7.6.17

[ Stock Market Strategy ] Buy in Dip vs Buy and Hold

Buying stocks on dips to earn extra return then switching to cash to wait for another pullback sounds like a good strategy. After all, buying low and selling high is what investors are told they should do.

But investing only on the dips, which involves some market timing, returns far less than simply buying and holding.

Under one simple version of the buy-the-dip strategy, an investor would wait for a correction—a peak-to-trough decline of 10%—before buying. The investor would then hold the stocks for at least 12 months or until the market recovers to the point where the investor bought the stocks, whichever is longer.

This strategy would have put you in cash about 47% of the time, so if our switches were random, we’d expect to earn about half the market return with half the volatility.

But the results were far from the expected. The buy-the-dip strategy would earn a third of return of a buy-and-hold strategy with much higher volatility.


Buy in Dip vs Buy and Hold Profit log scale

The chart above just shows you just how bad of a strategy buying the dip would have been.

What about waiting until there’s a big, outright market crash? A perfect example would have been to be 100% in cash by October 2007 and then wait until March 2009 to get back into stocks at the bottom.

Two possible reasons why the correction-timing strategy fails in the long:

 First, sitting in cash when the historical equity risk premium—excess return above a risk-free rate, such as the yield on a Treasury note—was high and bear markets rare would be costly.

The second reason has to do with market momentum: “The market tended to exhibit momentum more than mean reversion over yearslong horizons,

As strange as it sounds, you would have been better off buying when the market was going up and selling when it was going down, using a trend-following rule.

The strategy of waiting for a crash on average resulted in much worse absolute and risk-adjusted returns than buying and holding.