Stocks & Shares: Is Now The Time To Buy The Dip?

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Global stocks and shares posted their worst single day’s trading earlier this week since the first months of the coronavirus pandemic in 2020.

The FTSE All-World index, an acknowledged measure of global equity performance, plunged by 3% on Monday 9 May. The fall, which took the index to its lowest level since December 2020, was the market’s sharpest decline since June 2020.

Nina Etherton, investment analyst at wealth managers JM Finn, says the recent market fall was driven by investors re-pricing securities against the increasing likelihood of a recessionary, or even ‘stagflationary’, economic environment. 

‘Stagflation’ is the term for a period of slow or stagnant economic growth, set against the backdrop of high inflation. 

She said: “Persistent, high inflation has caused central bankers to begin putting the brakes on the economy by raising interest rates, which could come at the expense of growth. Ignoring the fundamental drivers for share prices can be dangerous, particularly in the face of these challenges.”

When a stock market corrects itself downwards, a question that’s inevitably asked is whether investors might be able to profit from associated plunging price movements. 

Kasim Zhafar, chief investment strategist at EQ Investors, says it is important to retain a sense of perspective: “Market fluctuations are an essential ingredient of investing. Share prices and the stock market can overreact in the short term.”

Buying the dip

The phrase ‘buying the dip’ – a reference to making money on the back of a stock market fall – is popular among active investor ‘day traders’ and cryptocurrency investors facing a backdrop of volatile markets.

As recently as this week, El Salvador’s president and prolific social media user, Nayib Bukele, took to Twitter to inform his 3.9 million followers that his country has “just bought the dip” in connection with a purchase of 500 Bitcoins at an average price of £24,000. 

Last year, El Salvador was the first country in the world to adopt the cryptocurrency as legal tender.

Ms Etherton explains that, In the world of mainstream finance, “a dip is a fall in financial markets, usually associated with equities, that’s dramatic enough to encourage contrarian investors to invest more into stocks, in an expectation of a reversal of the downward trend.”

Experts say buying the dip is a valid strategy. Poppy Fox, investment manager at wealth managers Quilter Cheviot, says: “There can be some sound logic in buying shares of companies after their price takes a tumble, particularly if you continue to believe in the investment case.”

Tom Stevenson, a director at Fidelity International, agrees: “Buying the dips has usually made sense.” 

According to Stevenson, in the 14 years since the financial crisis of 2008, it has generally paid to assume that central banks or the government would ride to the rescue at the first sign of trouble in the markets.

“‘Don’t fight the Fed’ has been a profitable mantra,” Stevenson comments, referring to the willingness of the US central bank, the Federal Reserve, to support the economy.

Bargain buys

Juliet Schooling Latter, research director at investment analysts FundCalibre, says buying the dip provides investors with the opportunity to gain exposure to an asset that they perhaps already liked, only at a cheaper price. 

She says: “The saying is that it’s time in the market that counts, not timing the market. Basically, investors should stay invested through the ups and downs as it’s impossible to get the timing exactly right each time.”

Ms Fox agrees about the issue of timing and adds that investors should only consider buying a dip in stock markets provided that they are a long-term investor: “It is incredibly risky trying to time the market and looking to trade when you see a good buying opportunity. As such, it is much more profitable to buy the dip and hold for the foreseeable future.

“Moving in and out of markets regularly, trying to time the bottom of a dip, could cause you to miss some of the best days and this can have a significant impact on the value of your portfolio. As a long-term investor, volatility should not worry you as you have time to ride out any subsequent dips.”

Buying a dip ideally allows investors to purchase shares at lower prices than was previously the case. There is also the opportunity of buying shares that have been oversold in the herd mentality rush to offload a stock.

If you’re clear about your reasons for buying a dip, then choosing whether to invest in shares directly, or funds, can depend on the amount you’ve decided to invest. Find out more here about investing in stocks and shares and the benefits of using Individual Savings Accounts to protect ring-fence your investments from tax.

Thought before action

Regardless of whether you invest in shares or funds, it’s also important to remember the benefits of maintaining a certain amount of diversification within your investment portfolio. Holding a mix of assets such as equities, bonds and cash can help defend your portfolio from financial shocks.

Investors might be tempted to divert spare cash into individual company stocks that have nosedived in price. Bear in mind, however, that doing this has the potential to alter the dynamics of an existing portfolio of holdings.

Alice Haine, personal finance analyst at investing service Bestinvest, says that pinpointing when the stock market has hit the bottom is “something almost no one can achieve”. 

She adds: “The best advice for those with a long-term approach is to invest in the markets at regular intervals, rather than aggressively piling in after a short-term move.

“Investing on a monthly or quarterly basis takes advantage of the technique known as pound-cost averaging. With this strategy, rather than buying a lump sum at a single price point, such as during a supposed dip, investors can buy smaller amounts at regular intervals no matter what the price is at the time.

“This cushions some of the effects of volatility in the short and medium-term and, by staying invested for the long term, investors can further moderate risk and increase the chances of decent real returns. In the long run, your investment costs should be lower and your returns higher.”