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Buying the Dip

During strong stock market rallies, most retail investors often feel left outside. The reason for such a feeling comes from either booking profits earlier, or because they have sold their stake at the first small correction. 

Therefore, strong market rallies are often the most hated market moves. Despite what a higher stock market implies (i.e., the wealth effect), investors that do not participate in the rally wait for their opportunity to go long.

However where to enter so to avoid buying at the top? How about buying the dip?

The Psychological Game Called Stock Market Investing

This week the stock market correction continued. The Dow Jones fell a hefty distance from the highs, and the S&P 500 did so too.

At the start of the week, the sectors that declined the most were the cyclicals. When this happens, it is usually a sign of the market worrying about future potential growth.

Later in the week, further signs of weakness emerged. Suddenly, the market looks nervous as it seems that we won’t see a second round of fiscal stimulus.

With the U.S elections less than six weeks ahead of us, there is unlikely to see more fiscal stimulus. Goldman Sachs just downgraded the Q4 GDP on the back of lack of additional fiscal stimulus. It lowered the forecast from 6% to 3% on an annualized basis. So there you go, investors willing to buy the dip have the dip right in front of them. But do they buy?

Human nature plays tricks on everyone, especially on those willing to take a risk at trading financial markets. The S&P 500 correction is now around -10% and beyond -20% a bear market officially starts.

This is how the market puts pressure on officials to act. Most likely, we will see/hear some intervention by the time the market decline reaches -15% or so. But that is exactly the reason why investors don’t buy the dip when they see one. Instead, the tendency is to wait and see if it breaks below -15%. And then, if it breaks into bearish territory. Finally, if it broke into bearish territory, why should I buy the dip? This is no dip to be bought!

The moral of this story is that the business cycle has a…cyclical nature. While the stock market advances or declines may get ahead of themselves, the cyclical nature always offers a dip to be bought.