Buy the Dip Trading Strategy: Rules, Backtest and Examples

Consider using stop-loss orders to limit your risk and trade small to save yourself from getting wiped out in a single trade. It’s just FOMO trading, and it tends to end in a bunch of losses. Consider starting with smaller positions the first few times you try to buy the dip. When learning any new trading strategy, you have to walk before you run. You should have a plan with an entry strategy, an exit strategy, limits, risk, and more.

  1. As an investor, it’s important to find a good balance between the risk you’re taking on and the potential returns an investment can provide.
  2. The chart below shows the S&P 500 index over the last 10 years with red circles indicating the periods where a 10% decline had occurred.
  3. Bitcoin exposure is provided through the ETF BITO, which invests in Bitcoin futures.

In this case they’re expecting that the stock price will bounce back as investors realize that the currently lower share price doesn’t reflect the actual strength of the company. There are plenty of ways to trade the “buy the dip” strategy. Long-term investors might buy any retracement bigger than a certain percentage level, while short-term traders might enter on pullbacks in a rising long-term trend, just like we backtested in this article. Buying a coin or token in a downtrend does not necessarily mean that its price is guaranteed to increase — the “dip” can always get “dipper”, making it difficult to know the right dip size to enter the market. The buy the dip strategy is just purchasing an asset (a stock or an index) after it’s fallen in value.

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It’s usually one of the first indicators day traders look at when evaluating potential trades. Volume, price action, price trend, momentum … you need to find which indicators work for you. They can help you determine when it’s the right time to strike.

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Buy the dip, sell the rip – mean reversion

Things can change in an instant, especially in today’s markets — that’s why you prepare your trading plan and study the patterns. When looking for a dip buy, support and resistance levels are crucial. If you don’t pay attention to the price action, you could increase your risk. Prepare for all possible scenarios in your trading plan — nothing should take you by surprise.

Buying the dips, in practice, involves holding a portion of cash or lower-risk liquid assets out of the market and waiting for market prices to fall. «Prices» in this context means the market values of stocks, bonds, index funds, or even cryptocurrencies. Buying the dip is a strategy that attempts to capitalize on the understanding that stocks move up and down in cycles, sometimes short-term, sometimes medium-term, and sometimes longer-term. Stock declines can serve opportunistic investors to buy the dip, lowering their entry cost (or average cost) into stocks they wish to own.

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Buying the dips tends to work better with assets that are in uptrends. Dips, also called pullbacks, are a regular part of an uptrend. As long as the price is making higher lows (on pullbacks or dips) and higher highs on the ensuing trending move, the uptrend is intact. The information contained on this website should not considered an offer, solicitation of an offer or advice to buy or sell any security or investment product. The information should not be construed as tax or legal advice.

Get the code for the strategy

Once prices have fallen — for whatever asset you’re tracking — you take all or some of the cash you’ve been holding and purchase more of the asset. This lowers your overall average cost and can enhance your returns, assuming you hold the asset long enough and higher valuations prevail over time. Unless you’ve specifically laid out in advance the price drop that would cause you to purchase more stock, it’s difficult to define a «dip size» that’s universally applicable.

While it is possible to experience a rebound after a significant price decrease, it is also just as likely for the asset price to continue declining. There are many cases where a particular security does not recover and continues to drop, leading to increased losses. But this is more likely to happen with individual stocks than with a broad market ETF that tracks an index like the S&P 500. So, be careful when practicing “buy the dip” on individual stocks.

Wait for the setup that works for you and fits your trading strategy. Word toward developing patience and wait for confirmation before you buy the dip. They jump in and out of all kinds of trades instead of waiting for one or two great setups. Following these steps could help you spot an opportunity to buy the dip. But none one of them will be useful unless you’re actually able to recognize when a stock is poised for a dip buy.