Trend Following Strategies for Buying the Dip:
In the current bull market, buying the dip in stocks has become a popular stock trading strategy!
In fact, readers often ask me what’s the best way to buy stocks in pullbacks. So…
In this detailed blog post, I’m going to share some of my favourite tips, tricks and tools for buying the dip in up-trending stocks.
By the time you’re done reading you should feel MUCH more comfortable about dip buying.
Because, you’ll learn:
- Why not all dips are created equal,
- How to avoid common dip buying mistakes (like catching a falling knife!); and,
- One of the FinViz screens I use to regularly find dip buying opportunities!
Sound good? Great!
Then let’s dig into the dirty details of how trend followers can use dip buying trading strategies to try and increase their returns.
“After all, dip buying looks like it has the potential to be a fantastic trading strategy!”
So with that in mind, let’s start this foray into dip buying trading by taking a look at which dips to buy and which ones to avoid. And by the way, this is quite a long post so you can download it here as a PDF for offline reading!
Dip Buyers Beware: Why Not All Pullbacks Are Created Equal
By now your probably appreciate that dip buying has the potential to be a great trading strategy.
Over the alert few years, dip buyers have been rewarded with handsome profits! But you know what?
“It won’t always be that way!”
Now I hate to be the bearer of bad news.
But someday the market will eventually go lower, for a sustained period of time. And dip buyers who don’t manage risk will see their portfolios go up in smoke.
On the other hand:
As long as this bull market keeps charging higher, odds are in favour of the dip buying traderAnd that’s why…
“Market context is key to deciding which dips to buy!”
I’ve written before about top down trading analysis. And this can be a valuable tool for traders who want to buy stock on a pullback.
Not all dips are created equal! And if you want the highest odds of success then you probably want to go with the line of least resistance.
In practice, that means confirming you’re still in a bull market by looking at the major trends in the indexes and sectors related to your trade.
If you’re trading tech stocks and see the long-term Nasdaq chart making higher highs and higher lows, you can likely feel more confident picking up shares…
Because chances are, if markets overall are trending higher, then your dip buying may be more likely to bear fruit!
“Bull markets put the wind in your dip-buying sails!”
Make sense? Good.
And hey, I get it. Buying breakout stocks can be difficult. I know first hand how it’s psychologically tough to pay up. So dip buying has appeal.
Just be sure you aren’t pushing the buy button when stock index weekly charts signal a downtrend! Because that’s a surefire way to limit your upside potential!
And instead, you might end up doing serious damage to your account. That’s why I encourage you to consider the major long-term trend in any market you trade in.
This big picture context is the reason not all dips are created equal. But by focusing on dips in uptrends you can start to capitalize on those with the most potential.
Now before I show you one of my specific dip-buying stock screens, let’s quickly cover a few more pitfalls that eager dip buyers can sometimes fall into.
Common Dip Buying Mistakes to Avoid:
In the previous section of this article, I explained how dip buying within an uptrend is much different than bottom-fishing during a market crash. But you know what?
Dip buying in downtrends isn’t the only trading mistake to avoid! Nope. Unfortunately there are many other expensive errors you’ll want to avoid when looking for a pullback to act on. So while not a definitive list, here are some other areas in which traders often err while trying to implement a “buy the dip” strategy…
(1) Don’t be the first person to buy the dip:
This is something a lot of beginning traders have trouble with. I know the temptation to get a bargain and jump in to buy stocks that are pulling back. But please, hold your horses!
Wait for the dip to actually bounce a little before you jump in and buy. For example, if the stock you’re watching pulls back 5%, wait for it to bounce 1% or 2% before diving in.
To do this, you probably want to zoom in your trading time frame a bit. If you usually trade on daily charts and are feeling an urge to dip buy, why not try zooming in to see the 30-minute candlesticks?
Are you starting to see higher highs and higher lows forming on this intraday timeframe? If so, you can feel more confidently pulling the trigger on your purchase!
Personally, I prefer to wait until near the close of the trading session to see the price action. And if the stock is bouncing into the close on high volume, I’m much more likely to buy the dip than if it can’t get off the mat into the close of the day or week. Make sense?
I know it can be tempting to rush in to hit the ask price. But a little patience can really pay.
(2) Consider Becoming Systematic in Your Dip Buying:
Everywhere you look, it feels like systematic trading is taking centre stage. But you don’t need to be a quant to implement a rules-based strategy. In fact…
It’s actually pretty simple to develop a pre-defined template to guide your dip-buying. And since trading pullbacks can be so fraught with emotion; I encourage you to spend some time defining what exactly a pullback is for you.
Because based on your trading signals, what you perceive as a dip can vary greatly! Are you looking for deep double-digit corrections? Or is the smallest bump in the road reason enough to reload your position?
Don’t worry: In the final section of this article I’ll show you how I answer these questions for myself. But since your situation is bound to be somewhat different, I encourage you to reflect on what would work best for you!
For example, maybe you’re most comfortable buying after:
- A pullback to a key moving average,
- A flat percent decline,
- A bounce at a previous level of technical support; or,
- A return to a certain price based on fundamental values.
As you can see, there are lots of different ways you might define a dip! So…
While I can share what I do (and the thinking behind it), you’ll probably want to adopt this to your own trading system. But before I show you what works for me, there’s one more dip-buying mistake I want to cover with you…
(3) Check the News and Assume the Worst:
By now, I hope it’s clear that my dip buying strategies are focused on shallow and quick sell-offs, in up-trending stocks. This means you probably shouldn’t see monumental declines as dip-buying opportunities.
At the time of writing this, shares of Chipotle Mexican Grill are selling off hard.
As you can see, this is a pretty mean sell-off, and not a dip I’d want to buy (in large part because the stock wasn’t in an uptrend in the first place). Further to the point though, a quick Google search reveals a true catalyst for the selling:
I think this kind of quick due diligence check is an important step in the dip-buying process. Truthfully, I wouldn’t be too optimistic about a bounce in this stock when there is a big negative news story hanging over it (even if you think the stock is “cheap”)!
And although I’m not an event-driven trader, I still think it’s worth checking for context to help adjust your mental expectations for the trade.
Of course, you always still want a detailed plan for when to sell your stocks. But this extra step of looking for a “reason why” can also make things easier.
On the other hand…
Stocks often sell-off for no reason at all! So you won’t always find a fundamental catalyst to explain a drawdown. In these cases, the coast might be more clear for dip buying.
Alright, I hope all my doom and gloom warnings about dip buying mistakes haven’t scared you away. Because now it’s time to get to the good stuff! Let me show you the steps I use to screen for dip buying stock picks!
Screening for Dip Buying Stock Picks:
Regular readers know one of my favourite tools for researching stocks is FinViz. And I’ve written extensively about how to find trend following trade ideas using this free stock screener.
I want to share with you how to adjust this strategy to help you buy the dip in high-potential stocks. Let me show you how this works:
First, you should know that most of the time I’m looking for stocks making new 52-week highs.
But by definition, a stock making a new high isn’t a dip-buying candidate!
Luckily, FinViz let’s you scan for stocks that are 0-5% below their highs. And this is where I like to start when strategizing how to find these trade ideas.
Here’s a quick video I made showing you the criteria I use to dip-buy stocks.
FinViz Dip Buying Stock Screen Video:
As you can see, I personally like to sort the results using the “charts” tab. This makes it very easy to scan the stocks shown on the screen to find the best ones.
If you’re not sure what to look for, the idea is to find stocks that are near their highs and still in strong uptrends. This way, we can still trade with the major trend to try and keep the odds of success in our favour.
A more relaxed version of this approach would be to look for stocks above a given moving average. Depending on your time frame and personal preferences, it could be a shorter 50-day moving average or a longer-term 200-day moving average.
The idea is just to dip-buy stocks that are showing a bullish tendency over your given timeframe. But I don’t stop there!
Remember, one of the common dip-buying mistakes is to rush in too early. You don’t want to be the first person to buy the dip! So what should you do instead?
Well, I like to add another filter to the scan above. Specifically: on the technical tab, there is a field called “performance.” I like to update this measure to be “today = up.” This way, you are focusing on stocks that are already starting to regain momentum.
And this is key!
Just think about it: you probably don’t have enough buying power to move the stock price on your own.
You need other traders to come into the market and bid your stock up. Therefore, to make things easier on yourself, why not look for stocks people are already bidding up?
I know this can be a little counterintuitive. But in my experience it pays to buy what other people are buying! So that’s the approach I take with my dip buying strategy. It’s pretty simple, but it works.
Now keep in mind…
Just screening for these technical criteria will cast a pretty broad net.
So depending on your investing or trading style, you can further refine this trading strategy to get the results you’re looking for. Let me quickly show you what I mean.
Other Dip-Buying Stock Screen Tips for Swing Traders:
In general, I prefer to screen broadly using tools like FinViz to get a sense of how many stocks are near their highs.
But from there, I’m quick to add layers to my scans in order to try and find the best potential trading opportunities. And dip-buying strategies are no exception!
So, here are some more criteria you can use to try and zoom in on the best pullbacks for you!
Not all traders pay heed to fundamentals, and I understand why. But…
If you’re trend following on longer timeframes (like me!) then I think fundamentals are worth noting. That’s because… in my experience at least… consistently profitable companies are able to trend higher for much longer.
On the other hand…
If you’re buying over-indebted and unprofitable companies, there might be a higher chance of being victim to an earnings miss, analyst downgrade or secondary capital offering. At the very least it’s feasible to believe other dip-buyers could lose conviction (and thus cause the stock to fall).
So by focusing on companies that can fund their own operations you might be able to tip the odds in your favour – and reduce the chance the stock won’t recover from the dip. Of course, there are many different ways to analyze fundamentals. But personally, I like to look for positive return on equity and debt/equity ratios under one.
For more free information on this approach, check out this detailed guide to scanning for stocks on FinViz. It doesn’t talk about dip buying specifically but the different fundamental screening, concepts can still be easily applied as another layer to your dip-buying approach.
(2) Market Cap:
It’s common for traders and investors to sort stocks by market cap. So if this is an approach you like to use, feel free to add your favourite market cap filters to our “buy-the-dip” screen.
This way, you can easily switch between large-cap blue chip companies with sold operating track records; or, more speculative smaller cap growth companies. While I tend to trade more of the former, you’re of course welcome to do whatever works for you!
Finally, when fine-tuning your dip buying screen, don’t forget about other technical analysis tools that may be of interest…
(2) Other Technical Patterns:
To be totally frank, I don’t do all that much trading based on classical chart patterns. But that doesn’t mean it can’t work for you!
If you rely on chary patterns in your trading then by all means you can add them to your dip buying arsenal. Indeed, FinViz actually makes this pretty easy with their robust pattern detection filter.
And even if you don’t trade off patterns, being aware of them can provide useful context. For example…
If you notice that a stock you like is pulling back into a level of support, you might be more inclined to buy the dip.
On the other hand, if there isn’t a trendline in sight then you might be more cautious before pulling the trigger. Make sense?
The point is, there are many way to trade stocks that are undergoing slight corrections to their share price. And done right, this strategy can really help you augment and diversify your returns vs. only trading breakouts.
You always want to be careful to manage risk, with careful position sizing and a clearly-defined stop loss.
Because the last thing you want is for a potential buy-the-dip opportunity to become a big stinking loss… right?
Exactly. That’s why I always have an exit strategy and prefer to focus on profitable companies in strong uptrends when I’m buying the dip. Of course, even this isn’t perfect. But it does help limit losses and improve the odds of catching BIG winners (and that’s what we’re all after, isn’t it?
Alright, and that’s it for now folks! So I hope you found this guide to buying dips helpful. And I hope you see why, especially in bull markets, this can be quite a profitable strategy.
And just be warned:
Even though buying the dip has proven to be a great trading strategy the last couple years, it won’t always be that way.
So if you’re thinking about dip buying I recommend you keep the above guidelines in mind: check the major market trend, focus on stocks that are already moving up and (as always!) be careful about managing your risk.
If you do all this right, then dip buying could just help you improve your edge!