We all have been there, the stock is down 30% last few months and it is down 4% on another piece of bad news today. Tempting to buy it? My strong suggestion is that you should not. While it seems intellectually elegant to buy dips, in general, odds are heavily stacked against you.
Buying the dips is a good strategy when the upward trend is well established (countertrend entry points are very effective!). Conversely, we often hear people say: why would I buy these stocks if they are so up much from their low? Again, you should never try to catch the bottom!
Here is the clearest analogy on why in investing, momentum tends to persist, conflicting human intuition for mean reversion. Assume you are walking up a high mountain in a complete fog – you can’t see anything beyond the next few steps. You have been climbing up for hours, maybe days, and have no clue about the height of the mountain or the length of the trail. You just keep ascending up and up and up… Yes, no mountains reach the skies and the higher you climb, the closer you are to the summit. But, having climbed for so long, what do you think your next step is likely to be: Up or Down? Again, all you know is that you were walking up for hours with no end in sight. Of course, it’s more likely that your next step will be UP! So, never bet against this in markets!
This analogy translates well into investing – right before you reach the top, the slope of the mountain would flatten out (most likely a few times) and will start cresting over. Same in investing. So control your instincts to fight the momentum – it tends to persist. Many indicators will clearly signal the turn to make your investing or trading more certain. You will greatly improve your investment returns by respecting the momentum. Don’t try to fight the momentum, remember: there are old traders and there are bold traders, but there are very few old, bold traders…
As Stan Druckemiller (arguably, one of the best investors or traders of all times) famously said: You make most of the money with the crowd.
Do you have your own observations when investors fall into predictable (yet, avoidable) traps?