The strategy of buy the dip is not ripe yet

The lack of volatility in the last one year made most of the market participants become buoyant and peppy. The markets were almost on a constant rise with not even a single five per cent correction in the whole of the last calendar year, while the worst of the month-on-month correction was a mere negative 1.25 per cent for only one month.

Naturally, this lets the individuals to ignore the risks and the incentive to stick for disciplined investing. All thanks to the XIV, inverted VIX (VIX is popularly known as fear index) and other fancied volatility-based instruments, the fear of not having ‘fear’ has caused for the sudden corrections in the US equity markets despite the bettering macro-economic indicators.

The spike in the inflation and the most eluded wage growth showing green shoots for the first time in about a decade also added fuel this pandemonium causing bears run amok last month. That disturbance has spread to the other markets and suddenly accentuated the inherent issues that were suppressed all this while and the narrative suddenly turned opposite.

Now that the volatility is back in the market, there are certain things we tend to do and some things better be avoided too. Re-introduction of volatility has suddenly changed the character of the market with momentum investing style conceding to value investing.

With the value investment in vogue, some of the strategies like buy the dip is a peril one could avoid ill-interpreting. It’s a known fact that timing the market is difficult and often times a futile exercise. Every fall doesn’t provide opportunity to enter and so buy the dip is not a great strategy if not considered holistically about the macros of the economy, the respective sector the particular stock one is considering. Also, the fundamentals of the company are to be looked with minutest of the detail to avoid any pitfalls.

The other saying sounds apt in these situations: ‘don’t catch a falling knife’. Unless one is sure of the stock’s fall is part of the broader market correction and as long as these circumstances doesn’t adversely impact the company in consideration then one could take exposure or average and even top-up the exposure.

And in these situations, generally, these falling stars would make a bit of bounce in between. Sometimes described as ‘dead cat’s bounce’ is a resistance of the stock to the overall negativity in the market. The resurgence could be due to its innate strengths or could be due to the sustained entries by other investors taking exposure unware of the falling knife. So, one could wait for a while for the conformity of the bounce. This could possibly make one miss the ideal entry point, but the risk is mitigated by an extent. Again, remember the golden rule that of timing the market is difficult while the individual’s risk capability comes to fore.

Despite any market conditions, one should always stick to the picking the stocks on merit. When I meant by merit, the fundamentals of any stock should be looked with an utmost criticality and any compromise on this parameter is a sure recipe for disaster. Cash flows are important and a positive operational cash flows tells that the company is not too dependent on credit and is operating more rationally.

Though, avoiding a systemic risk is not possible, one could choose a stock which has lesser regulatory changes or a company which operates in a stable or matured regulatory environment.

Presently, the market is at an interesting juncture moving off from the earlier highs but still is taking cues from the various geo-macro issues like growing bond yields, reflationary concerns across globe, central banker interferences, strengthening oil prices and a subdued US dollar. Of course, the political risks remain as ever. In this back drop, the strategy of buy the dip is not ripe, yet.

By: K Naresh Kumar
(The author is a co-founder of Wealocity, a wealth management firm and could be reached at [email protected])