The idea is to buy a market when it retraces after a period of strong growth, and then profit if the uptrend resumes. For example, if Netflix’s stock is experiencing a long-term uptrend but then falls from $500 to $460, at this point the stock could be bought in the hope that the strong growth resumes.
In theory, the risk is lessened as the long-term trend is bullish, so in buying a stock during a dip the investor capitalises on entering the market at a lower cost.
There is no guarantee that the long-term market trend will continue, though. Sometimes ‘the dip’ will be the beginning of a prolonged downtrend, in which case investing at the lower price will still incur a loss.
How do you buy the dips in stocks?
Buying the dip in stocks involves identifying listed companies that have seen their price fall in the short term after a long-running uptrend. You then buy them at their new lower price, hoping that the bull run will resume.
This may sound like a simple concept, but executing it successfully can sometimes be difficult. It’s not always obvious how quickly, if at all, a market will recover after experiencing a price dip.
It’s also common for investors to buy the dip on stocks that they already own to average out the total cost of their investment. However, if the market then suffers further losses, buying the dip would have only doubled down on the loss they will incur.
Buying the dip is especially popular with stocks. Many major stocks experience a long-term upwards trend over several years. Meta (formerly Facebook), for example, saw its share price triple infive years.
Bid/Ask spread definition
The bid/ask spread is the difference between a market’s buy (bid) price and sell (ask) price. For example, if the actual price of a market is £100, the bid price might be £101 and the ask price £99. This makes the spread £2.
Every trade that is made requires one seller to be willing to offer the market or asset at the same price that a buyer is willing to take that same market. Therefore, the bid price can also be considered as the highest price a trader is willing to enter a market at. The ask price is the lowest price a trader is willing to offer that market at.
As a market’s price moves, so too will the bid and ask prices. The spread often stays constant, even when the price rises or falls. An exception to this is when volatility hits and there’s added uncertainty to the markets.
Different markets will have different spreads. For example, spreads are often higher for volatile, unpredictable markets. There’s a greater risk to the broker as prices are more likely to move heavily in either direction.
To offset the increase in risk, market makers will set a higher spread by raising the buy price and lowering the sell price. If a market is experiencing a lack of liquidity, spreads may also be larger as it’s more difficult to match a buyer with a seller.
Scalpers, who look for small profits by opening and closing multiple trades over a short period, are particularly impacted by the bid/ask spread. Every position traded will incur the cost of the spread, so the small gains made from scalping must be greater than this cost to be profitable.
For those with a longer-term outlook, the spread is far less significant as it’s assumed the profit incurred from any long-term price move will greatly outweigh the cost of the spread.
Do you buy at the bid or ask?
Assets are always bought at the bid price. The term bid and buy in this context are interchangeable, so often the bid price will simply be called the buy price. Similarly, the ask price is the same as the sell price.
If you want to long a market, this means taking up a buy position. You will open the buy position at the bid price. By going long on a market, you are hoping its price rises and you can close out the position at the ask price for a profit. Alternatively, if you are shorting a market, you will open the position at the ask price and close it at the bid price.