Buying the dip
Adventures in personal finance
Prologue:
As I have mentioned earlier as well, am not really a seasoned investor or experienced trader. I am mostly like the average nerdy guy next door, who has a job in IT and spends most of his days in lockdown and zoom calls.
Saving money never came easily to me, for a simple reason. I never made that much to start with. So I simply never bothered and lived paycheck to paycheck.
But slowly with age, the tougher realities of life started to rear their head up 😊
Responsibilities
Family
Financial discipline to provide family security
Fear of old age and unemployment
On the positive side, with age my earning improved marginally
Number 2 and number 4 were the primary reasons, I was forced to put some attention into learning how to save, which then forced me to try and understand a bit more about investing
It was while making a retirement plan, that I actually understood compounding and the benefits of it. This was the start of a rabbit hole of personal enlightenment. I realised that traditionally saving 30% of salary would not be enough in creating any form of wealth or future security, if it was not invested wisely.
Many excel sheets later, I thought I had the inkling of a plan and it was then that I decided to document my own learnings, failures and successes.
I decided to call it “Adventures in personal finance”
PS: These are my own learnings. None of this is, or should be taken as financial advice, in stock trading or savings creation
“Buying the Dip” is what I decided to write about first, because there is so much interest around this phrase all over the media.
So let’s dive in 😊
Common sense says that you can only make a profit, when the market or someone is willing to pay a lot more for a good, service, product or stock which you already own for far less.
And that is the entire philosophy around the popular stock phrase “Buying the dip”
So what happens?
Public companies often face volatility in the market due to macro or micro economic factors. Example of a macro trend would be Covid 19. Example of a micro trend would be a roll back of a faulty product.
Volatility of any kind, causes stock prices to fluctuate.
This happens for various factors. In an information age where everything from supply chains and projected sales can be tracked, analysts ( read Wall Street suits) define what a successful quarter for a company should look like in terms of sales and earnings per share (EPS). (Earnings per share (EPS) is calculated as a company's profit divided by the outstanding shares of its common stock)
Companies themselves give guidance on how much revenue and EPS they will deliver to shareholders in upcoming quarters to garner continued investment from shareholders.
When this number adds up or over performs, stock prices more or less stay stable or grow with average 5-15 % returns.(ballpark). When this number falls below expectation, there is knee-jerk reaction and the market often sells the stock which brings the price down.
This is called the dip.
However, unless something is fundamentally wrong with the company, these are often short term reactions in response to market signals. Most successful public companies have strong product lines and defensible moats and work hard to get the stock price up by improving performance.
And this is where “Buying the dip” can be lucrative for shareholders.
People who can predict rightly (with data, insights and experience) and keep buying a stock which is losing market value — because they expect it to rebound in time; stand to make outsized profits when the stock starts to rise up..
These returns are far higher than the standard average of 5-15%.
But am not a suit and I don’t have 20 years of experience in trading stocks, so here are the steps I take before attempting to buy the dip.
Stockpiling
Stockpiling is the strategy of buying more stocks which are “on sale” or trading below their considered fair value market price. This only happens when there is a sudden pullback in the market due to economic, political, or societal macro trends which cause people to be cautious about spending and hold on to their purses. Stockpiling is the investing strategy that actually creates the fastest wealth.
Unfortunately, stockpiling events don’t happen often.
So how do you recognise it and when can you spot it?
Step 1: Monitor sharp dips in a short time duration.
Experienced traders with deep pockets have very diversified portfolios spread across different industries. I neither have the pockets nor the experience. So I stick to mostly technology stocks which have shown guaranteed returns over 10 years and those which are poised for growth,
My alert is to track a targeted set of stocks if they fall below 10-15% in 7 days.
Given my novice stature I only track a handful stocks in one particular sector (technology) since I understand the products and because that’s the only news I read
I also notice if there are other sudden dips across other kinds of stocks - like if the trend is uniform or sectoral
I then research on news on plausible causes that this might be happening
Step 2: Monitor news and social media
Compile a set of stocks that may be selling at lower than considered fair value market price within technology
Check if there is bad news, regulatory issues, product problems or legal battles taking place within these companies
Check on sentiment in social media because that can quickly go viral and cause massive perception change overnight
If the news is overtly negative then avoid buying more of that stock when it’s “on sale”
Step 3 - Check on Quarterly earnings and S1 filings
Check on EPS and if it came below analyst expectations. If it did, check the percentage dip. If there is a 20-30% decline then I hold off buying more of an “on sale” stock. If the EPS is nearer analyst expectations then it might be a safer bet to buy into the dip (provided other factors look solid- keep reading below)
Research S1 filings to understand the companies future outlook, past performance, product pipeline and risks. If it seems like their fundamentals are strong and they have a healthy product pipeline or planned increased investment, which people would be interested in, then based on the above pointers I proceed with caution in buying more.
Research their offerings and competitor offerings in the same space. Look to understand if that core offering has demand and will continue to have demand in the next 3-5 years
I personally only invest whatever little I can. I certainly don’t have tens of thousands of dollars to take massive bets, but that’s ok with me. My returns are a lot less, but my risks as well.
I also try and watch the decline rate. If a company stock price has been declining steadily over a period of time (ie not a sharp sudden fall) - then what is means is that the market thinks that the stock is overpriced and in such cases I try and stay away from buying more of that stock. I may even consider selling it.
The most important thing is tracking and understanding the overall market sentiment. The best stockpiling alerts are when the entire market pulls back suddenly. This generally happens due to a significant incident (globally or locally) and the causes can be political ( change in government), economic (Budget / inflation etc), societal (natural occurrences) and so on.
. The most recent example of this was Covid-19.
Around February 14th, 2020 the S&P 500 was at $3,300.
By February 28th, 2020 the S&P 500 went down to $2,800, a 15% decline in 2 weeks.
By March 20th, 2020, the S&P 500 went down to $2,300, a 30% decline in 4 weeks.
By April 14th, 2020, the S&P 500 went back up to $2,800, a 21% increase in 4 weeks.
By August of 2020, the S&P was already at $3,400, another 21% increase in about 3 months.
In 4 months the market had reversed to $3400 in August from $3300 in February
So in case you have liquidity (and it can be as little as you want it to be) and you can keep buying the right set of stocks (based on your research and your own conviction - earnings and S1 filings are very important data sets) while the market is selling, then there is every possibility that you can make outsized returns.
There is also every possibility that some of your analysis goes wrong and you lose money in the process. To be honest it is inevitable at times.
So to minimise that, I am strict when it comes to how much risk am willing to take. I only apportion an amount that am willing to risk and lose entirely it is comes to it when buying the dip. In addition, I don’t wait for the lowest point of the dip to buy. As soon as I feel there is a fair advantage at a 10-20% decline I buy in a measured way and then hold for the market to correct itself.
Sometimes I win, Sometimes I lose, but in every instance I learn.
Other tools and resources that can help you be informed and educated to make your own decisions are services like
Seekin Alpha
MorningStar
Motley Fool
Yahoo Finance
Google Finance
Free Stock Screeners ( or even nominally priced ones)
There is a saying (and more of a meme these days). It says - stocks only go up.
So watch that meme. But do your own due diligence. Take time. Research and read. Start small. Learn. Love excels. Build your own macros.
And buy the dip when you feel the time is right.
About Me:
In my day job I drive growth at Google. Ex @ Adobe, SAP, LinkedIn and IBM
In this newsletter I write occasional essays on investment, self improvement, market trends, venture capital and growth. Follow me on twitter @hackrlife
If you are interested in books and historical letters check out the Quotatist.