It's one of the most basic rules of investing – buy low, sell high. One of the best ways to implement that rule is to "buy on the dips." That is, invest your money when the overall market falls, or the price of an individual stock retreats.
Advocates of the strategy include legendary investor Warren Buffett. Many other investment advisers believe in the strategy, but with some important qualifiers.
"It's the contrarian way of thinking – buying when others are selling. Not following the herd. And it works," says Allan Small, a senior investment adviser at HollisWealth. He says buying individual stocks when the overall market drops can be a winning approach.
"If an investment falls based on factors that have nothing to do with the company itself, that can be a great time to buy that stock" or other investment, he says.
Robert "Hap" Sneddon agrees with Mr. Small, but only under certain conditions. Mr. Sneddon is president and chief portfolio manager at CastleMoore Inc. in Toronto. He primarily uses technical analysis to scrutinize the market – that is, he studies the ups and downs of stocks to guide his investing decisions.
Buying on the dips is a good investing strategy, but only if an investor can accurately identify whether the investment is in an overall up or down trend, he says. "To buy the dips without getting confirmation of the trend can result in a loss in capital, and, just as importantly, a loss in confidence," he says.
Lyle Stein, managing director and senior portfolio manager at Vestcap Investment Management Inc., has a slightly different perspective. Mr. Stein says the question of whether buying on the dips is a good strategy depends on your definition of investing.
"For many people, and increasingly more so, investing is a polite way to describe trading, or even speculating," he says. "Buying dips, in my view, is more about responding to a sudden change in price than a sudden change in long-term value."
For a trader with a short-term investment horizon, buying dips makes more sense than for a true investor with a long-term horizon.
One factor to consider is whether to buy when the overall market dips, or when individual stocks you may be looking to purchase lose value. Mr. Sneddon notes that buying a dip in an individual stock is a higher-risk scenario because you may not appreciate the significance of fundamental information, or discount it too much.
"An individual stock may be down for good reason, and it will stay down or fall even more as the news rolls out," he says.
Mr. Stein echoes these comments, saying that before buying on a dip it is important to determine what caused the price to fall – was it a general market selloff, an industry event, or a company-specific factor? The more specific the cause, the greater need for caution.
One criticism of buying on the dips is that it is a form of trying to "time the market" – that is, predicting when it is going to begin a sustained up or down trend. This strategy is widely considered to be a bad idea.
"Any time a buy or sell decision is executed, there is an aspect of market timing," says Mr. Stein. "Mathematics don't lie – the only way to beat the market is by weighting differently or trading."
Mr. Stein points out that trading has its own costs, which in the long run detract from performance. Over the short term, however, a few winning trades can add significantly to performance.
Mr. Small does not believe that buying on the dips is trying to time the market.
"My job is to recommend investments to clients that will allow them to meet their financial goals. If I can find them something that is cheap right now for whatever reason, I will buy it and take advantage.
"I try to put money to work when I see something that looks to be a good value, just like someone buying a good quality sweater when it is on sale. I shop the stock market to find good quality names at good prices because in life you never want to buy something that is overpriced. That is not market timing."
Here's how Mr. Sneddon puts it: "The emphasis should be to get the odds in your favour as much as possible, then let 'er go. Is this timing the market? I don't know, but it's certainly managing risks versus rewards."