Buying the dips: neither good nor bad, it seems to me

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nisiprius
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Buying the dips: neither good nor bad, it seems to me

Post by nisiprius »

Whenever the market goes down someone is apt to say something like "Sweet. I'm accumulating!", or "Great! I always like to buy things on sale."

Whenever I read remarks like this, I'm tempted to cite the gambler's axiom "the dice have no memory." Or to put it another way, the law of averages works by swamping, not by compensation.

Suppose you flip a fair coin ten times and it comes up heads ten times in a row. At this point you've flipped heads 100% of the time.

Now suppose you flip it some more. The odds of its coming up heads are 50%, same as before, no greater, no less. The most likely outcome if you flip it a thousand more times is that the next thousand tosses will be 500 heads, 500 tails. If you add the initial run of ten heads, you get 510 heads, 500 tails = 51% heads.

That's the law of averages at work. The first ten heads weren't counteracted or balanced, they were just swamped out by a long run of further flips that ran about true to average.

Apply this to an efficient market in which the market price is a random walk around some underlying trend. Let's say you believe the underlying trend is for a 7.1% return going forward, i.e. doubling in ten years.

If your stock index fund is worth $14,000 now, then in ten years you expect it to be worth $28,000.

Now let's say the market suddenly drops and your stock index fund is worth $13,000. Your expectation should still be a 7.1% return going forward from the present time, so at this point your expectation should now be that it's going to be worth $26,000 ten year from now... and that any more stock you buy "on the dip" should behave the same way, not better.

If the expected happens, people who bought the index fund at $13,000 will see $26,000 = a 7.1% annual return in ten years. The people who bought it at $14,000 who see a terrible "loss" of 7.1% in a couple of days when it dropped to 13,000. If they don't panic and patiently hold out for ten years, they will see their $14,000 become $26,000, 6.38% annual rate of return. They indeed recover from their loss and make something approximating the expected 7.1%. But that's not because the stock market compensated for the drop, it's just because the longer-term behavior swamped out or diluteds the short-term variations.

Believing that "buying the dips" is advantageous assumes that you're buying the same thing after the dip as you did before. But you're not. In most cases, you're buying a company that has just announced disappointing profits or something like that, so it's not as good as it was before.

Suppose you were about to buy a used car from a friend for $14,000, and he called you up and said "I'm sorry, someone hit it in the parking lot and made a dent and a big scratch on the side. I have an estimate from a body shop that it would take $1000 to fix it. You can have it for $13,000 now." What would your reaction be?

Would you say "Oh boy, this car is a much better deal than it was before, because the price just dropped $1000? Sweet! I like to buy cars when they're on sale!"

No, it's about as good a deal as it was before, no better, no worse.

This doesn't mean there's anything wrong with buying the dips, but I think it's a delusion to think that there's any reason to go beyond buying enough to maintain one's chosen asset allocation.
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Post by buyza »

I somewhat disagree. Here's why.

The 14000 that is expected to be 28000 after 10 years, if the dip to 13000 is just one of the volatile days that is calculated into the expected return. When you assume that you will get the 100% return over the 10 years, you do not expect it to ONLY go up every single day in small increments. You expect typical market activity.

If that is the case, when you buy on the dips of the already calculated in activity, you are just lowering your overall cost per share, and will therefore increase your overall return % wise.

Example:

If you buy 10 shares of a global index at 100 dollars and expect each share to be worth 200 in 10 years. And then a month later there is a drop to 90/share and you buy 10 more. You now will own 20 shares at 95/share and when they are worth the expected 200/share in 10 years, you will have gained an extra 5% per share.


As for the car example that is a false analogy. You can not compare a car with irreparable damages to a market that can rebound without you paying to repare it. The price of the stock can drop for any number of reasons, not just a bad quarter. Market uncertainty, fears of recession, fears of inflation, people afraid that it is getting to expensive, etc. All of which is figured in to the expected return. You are going to have bad quarters and good quarters.

Now if you say the market isn't in fact expected to achieve the return after said period of time, then it would not matter when you buy since you will be a loser.

Just my 2 cents.
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dips

Post by pkcrafter »

Thanks, good logical post. In your example, the dip is 7%, but a lot of posters here are buying on dips of 1-3%. Let's not forget that half the time, the small dip that you bought on could be followed by more dips. You shoulda waited.:( And occasionally a small dip might be the first step off a cliff.

Paul
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Post by market timer »

If you assume a random walk, you've made your life too easy.

You should read about the evidence against the random walk hypothesis:

A Non-Random Walk Down Wall Street
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Re: dips

Post by buyza »

pkcrafter wrote:Thanks, good logical post. In your example, the dip is 7%, but a lot of posters here are buying on dips of 1-3%. Let's not forget that half the time, the small dip that you bought on could be followed by more dips. You shoulda waited.:( And occasionally a small dip might be the first step off a cliff.

Paul
Thats why I buy in small increments on dips, and continue to buy on the way down.

The biggest mistake is dumping all of your cash on 1 dip.
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Post by MERobison »

I agree with buyza's posts... also why it is important to buy index funds, as it will help protect against the steep cliffs that pkcrafter mentions.

Either way, the point is not to try and market time. If you buy some on a dip, you are better off. So what if it dipped farther afterwards and you didn't get that lower dip. You are still better off for the dip you did get.
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Post by livesoft »

I thinking buying on dips is not like flipping a coin. The reason is that when you buy on a dip, you already know what the outcome of the coin flip was.

To expound on this some more. If you are going to invest every month, you can have a simple rule: Invest on a day when the market is down by 1.5% or more, but if one does not occur invest by the end of the month.

The proverbial studies show that if you miss the 10, 20, ... N worst days in the market, then you come out way ahead. It is easy to know which day is a worst day becaue the news media tells you continuously throughout the day. All you have to do is invest within 10 minutes before the stock market closes. Any cash that you invest on such a day has missed one of the worst days. You know what the coin toss was by the time you invested: it was down.

Conversely, if one is going to rebalance out of equities, then do so on a best day. You will know which day is a best day because the news media tells you continuously throughout the day. All you have to do is sell within 10 minutes before the stock market closes.
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Post by market timer »

livesoft wrote:I thinking buying on dips is not like flipping a coin. The reason is that when you buy on a dip, you already know what the outcome of the coin flip was.
How is this not consistent with the OP? If you assume the market is a random walk (a typical Boglehead assumption), then it doesn't matter what the previous day's "coin toss" revealed.
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Post by biasion »

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Post by woof755 »

I'm the owner of the "Sweet. I'm accumulating" post to which the OP refers.

By accumulating, I mean literally in the first stages of what will be 20+ years of investing. What I've done up to now will become a small percentage of the sum total (we assume, right?)

So, I don't mean yesterday's dip, or the dip of the day before. I mean ,there seems to be an awfully big mess out there. "Past history" would suggest that it won't last forever (otherwise, none of us would be "buy-and-hold"ing), but however long it lasts, being in the market with several months or years worth of reduced prices would be a good thing.

And history would suggest that our current market isn't going to be 14,000 at the end of this year...then 15,000 the next, and 16,500 the next, and so on. This point was alluded to earlier.

Sure, some company whose earnings report was a penny a share lower than "market expectations" isn't in as good a position as it was the quarter before. But that doesn't necessarily mean that the stock can't rebound in the future. A company with a bad quarter isn't like a car with a ding--it's not permanently damaged, and in fact might come out even stronger having learned from the experience that led to the bad news.

So, I couldn't disagree more with the OP's penultimate statement.

And I couldn't agree more with his / her final comment.
"By singing in harmony from the same page of the same investing hymnal, the Diehards drown out market noise." | | --Jason Zweig, quoted in The Bogleheads' Guide to Investing
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Post by grayfox »

If you bought yesterday at 1453 and it drops on Monday to 1350 and I buy, I will have a greater return than you forever after no matter what the market does. No forecasting or modeling is necessary to prove it. It is just arithmetic.
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Post by market timer »

grayfox wrote:If you bought yesterday at 1453 and it drops on Monday to 1350 and I buy, I will have a greater return than you forever after no matter what the market does. No forecasting or modeling is necessary to prove it. It is just arithmetic.
While that's true, it doesn't directly support the strategy of buying on dips.
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Forgetabout it

Post by Taylor Larimore »

If you bought yesterday at 1453 and it drops on Monday to 1350 and I buy, I will have a greater return than you forever after no matter what the market does.
However:

I you bought yesterday at 1453 and it goes up on Monday to 1550 and I buy, I will have a worse return than you forever after
no matter what the market does.

If there was a buy or sell scheme that worked, everyone would use it--so forgetabout it.

Best wishes.
Taylor
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Post by grayfox »

I you bought yesterday at 1453 and it goes up on Monday to 1550 and I buy, I will have a worse return than you forever after
no matter what the market does.
That is not buying on a dip.
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Trying to beat the market by buying on dips?

Post by Taylor Larimore »

you bought yesterday at 1453 and it goes up on Monday to 1550 and I buy, I will have a worse return than you forever after
no matter what the market does.
[quote/]
That is not buying on a dip.
Buying on a "dip" or buying on a "bounce," the investor who buys at the lower price wins--and no one knows tomorrow's price.

Best wishes.
Taylor
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strategy for "buying on dips"?

Post by darko »

What's the strategy for "buying on dips"? Suppose you get paid on the 1st each month and want to invest that month. Do you wait for the first day when the market drops some amount, say 1%, to buy? What if there's no such day; do you just buy at the end of month? Is the claim that this strategy makes you buy at a lower price on average (on top of the interest you get for keeping cash until you buy)? This should be easy to backtest; I think even I could write an Excel program to do so. :)

Please let me know if I misunderstood the strategy. What "dip percentage" should one use? I assume the result to depend greatly on the percentage, but that waiting to buy is worse for longer periods.
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Post by nisiprius »

livesoft wrote:The proverbial studies show that if you miss the 10, 20, ... N worst days in the market, then you come out way ahead.
Yes.
It is easy to know which day is a worst day becaue the news media tells you continuously throughout the day. All you have to do is invest within 10 minutes before the stock market closes. Any cash that you invest on such a day has missed one of the worst days. You know what the coin toss was by the time you invested: it was down.

Conversely, if one is going to rebalance out of equities, then do so on a best day. You will know which day is a best day because the news media tells you continuously throughout the day. All you have to do is sell within 10 minutes before the stock market closes.
The news media don't know whether it's the worst day in the current month, so I assume you're talking about reports mentioning that it's the "worst since" some time or other.

Livesoft, do I take it, then, that your rule for buying is: at the start of the month, wait for a financial news story about the market that uses the words "worst since," and buy near the end of the day; otherwise buy at the end of the month?

Is that a correct description of the rule?

Have you personally followed this rule and kept records?

In the case of a mutual fund, is there really a difference between placing an order 10 minutes before the stock market closes and placing one later that same evening?

I very, very rarely trade individual stocks and when I do I don't pay much attention to how they're executed... I don't really know how it's done... is it really possible to buy a stock during "the last ten minutes" of a day that has made news headlines and have your trade certain to be executed? Do you know what price you will really pay (or do you specify the kind of trade, whatever it's called in which you name the range of prices you're willing to pay).

I've been truly amazed at the intra-day volatility on "newsmaking" days. Just this year I think there have been days when around lunchtime the finance web pages were indeed using words like "plummet," "tumble," "plunge," etc. and the Dow was down a couple of hundred points from the opening, and yet had made it back to essentially the starting point by the close. In deciding whether to buy, what news source do you use, and at what time of day do you interpret the headlines?
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Post by pkcrafter »

MERobison wrote:
also why it is important to buy index funds, as it will help protect against the steep cliffs that pkcrafter mentions.
Unfortunately, an index fund will not help protect you in a market decline. The total stock market index is 100% stock and will faithfully track the market wherever it goes. Your only defense against a full market fall is to own a parachute (some bonds and cash) and to be fully diversified. But don't conclude from this that index funds are not excellent investment choices, they are.

market timer,
If you assume a random walk, you've made your life too easy.

You should read about the evidence against the random walk hypothesis:

A Non-Random Walk Down Wall Street
I read your link and as I understand the conclusion, it says the market is not random, but they are still trying to figure ways to exploit this. Of course that is always the problem. At any rate, average investors are far better off investing as if the market were completely random.

The whole idea of buying on dips sounds something like a timing system or some other strategy that will increase returns. I suggest those of you who believe this do a Google search on "buying on market dips strategy"

http://www.thesimpledollar.com/2007/11/ ... ck-market/

Embracing a "buying on the dips" strategy literally destroyed vast fortunes starting in March 2000, especially for technology and telecommunication stocks

You will also find references to buying on dips as a strategy, but these strategies are always discussed in terms of timing or charting. If you want to do this, that's fine, but clearly it is not recommended by the Boglehead philosophy.

Paul
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Re: strategy for "buying on dips"?

Post by House Blend »

darko wrote:What's the strategy for "buying on dips"? Suppose you get paid on the 1st each month and want to invest that month. Do you wait for the first day when the market drops some amount, say 1%, to buy? What if there's no such day; do you just buy at the end of month? Is the claim that this strategy makes you buy at a lower price on average (on top of the interest you get for keeping cash until you buy)? This should be easy to backtest; I think even I could write an Excel program to do so. :)

I do "buy on dips", but I view it as a strategy for indulging my ego, not for improving returns. Without some outlet for letting my ego think it is having an impact, I risk letting it break out into full-blown market timing.

I make contributions to tax-deferred and taxable accounts every month. The tax-deferred part occurs in fixed amounts on the first working day of the month. But on the taxable side I don't have an automatic plan setup, mostly because the amount is too variable. Some months have higher expenses than others (property or income tax due), or some extra cash is coming in.

But by the last week of the month I generally have some idea of how much of the next paycheck will be available for investing. If an opportunity -- dip -- arises, then I'll go ahead and do an exchange from my MMF (also the emergency fund), and then replace that money when the paycheck shows up. For example, the taxable investment from my November 1 paycheck I made on October 19, after the S&P 500 dropped 2.5%.

If no dip opportunity arises, I invest on the first convenient day after my paycheck shows up.

Does this improve my returns? I have no idea, but suspect that in the long run it doesn't matter. Certainly if stock prices were a random walk it is slightly better because I am occasionally buying earlier ("borrowing" from cash) and earlier is better on average.
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Post by grayfox »

Maybe a better example is needed.

Suppose I decide I will invest in 10-year U.S. Treasuries only if I can get 5%. That is the rate I determined I must get to induce me to lend for 10 years. Otherwise I will keep my money in a money market fund.

Last May the 10-year rate was 4.6 to 4.9 percent. I think mmf were paying about 5%.

Then in June the price dips and the 10-year rate goes above 5 percent. I buy on the dip and get the 5% for the next ten years that I required. (hold to maturity)

If I bought when it was 4.6% my return would be 4.6%. Buying at 5% my return will be 5%
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Re: Forgetabout it

Post by iceport »

Taylor Larimore wrote:If there was a buy or sell scheme that worked, everyone would use it--so forgetabout it.
Well, Taylor, I respectfully submit that there actually is a scheme that works beautifully. There's no guesswork involved, and it's virtually guaranteed to boost your returns by substantial margins!

If I understand the biggest challenge in "buying the dips", it's that there's some guesswork involved in knowing if you're at the bottom of a dip. This time-tested strategy solves that problem. The only trouble is, it's only available to those that already have large sums of money and hefty salaries.

It's called "stock options backdating". :wink:

Sure wish I could do that! (But as long as a I can't, you can be sure I'll follow your advice.)

--Pete

(Why "insider trading" is illegal and this scheme isn't is beyond me.)

EDIT: PPS: My apologies to the OP. Your post was very thought-provoking and well reasoned. I'm an adherent to the random walk theory, even as I learn more about it through, of all things, Malkiel's A Random Walk Down Wall Street.

Still, I'm not sure the damaged car analogy really works here. If the "dip" was caused by more perception -- or psychological investor behavior -- than actual value, then wouldn't it be reasonable to conclude that in the long term the currently depressed price does actually represent a bargain? I'm not advocating the strategy, as it's not reliable, especially considering the trading and tax costs of doing so. But if the bottom of the dips could actually be predicted...?

(This really is a complex concept.)

--Pete
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Post by livesoft »

nisiprius wrote:The news media don't know whether it's the worst day in the current month, so I assume you're talking about reports mentioning that it's the "worst since" some time or other.
Yes, the worst since 'some time' are compelling days to consider purchasing. But one can set their own number: DJIA down 200 points, a specific ETF down 4%, whatever you want.
Livesoft, do I take it, then, that your rule for buying is: at the start of the month, wait for a financial news story about the market that uses the words "worst since," and buy near the end of the day; otherwise buy at the end of the month?

Is that a correct description of the rule?
Close enough.
Have you personally followed this rule and kept records?
Yes. I generally only buy on down days and not through some automatic investment program. My 401k is automatic with my paychecks, but I have not contributed to it since last March.
In the case of a mutual fund, is there really a difference between placing an order 10 minutes before the stock market closes and placing one later that same evening?
I do not use mutual funds. I use ETFs. With an ETF you can buy with a limit order. With a mutual fund, many places will not enter the order until the next day.
is it really possible to buy a stock during "the last ten minutes" of a day that has made news headlines and have your trade certain to be executed? Do you know what price you will really pay (or do you specify the kind of trade, whatever it's called in which you name the range of prices you're willing to pay).
Yes it is possible to have your trade certain to be executed. And you can know the price you will pay if you submit a limit order.
In deciding whether to buy, what news source do you use, and at what time of day do you interpret the headlines?
I just look at the current market prices for the DJIA, S&P500 and the ETFs I am interested in. I use moneycentral.msn.com, reuters.com and nytimes.com for most of my news sources. These sources get feeds from many other sources. I am looking throughout the day, but do not need to make a decision until after 3:45 pm eastern time. I tend not to buy on Friday's though.

Note that buying on the dips does not mean things do not drop further. Case in point: I bought DGS on 11/7 and 11/8 and it dropped on 11/9. Before that my previous purchase was GWX on 8/16. I had sold DLS the same day so this was a tax-loss harvesting trade, but I bought excess GWX, too. I dipped into my emergency fund to buy , so since 8/16 I have been replenishing my emergency fund.
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Re: Systems

Post by MERobison »

pkcrafter wrote:
MERobison wrote:
also why it is important to buy index funds, as it will help protect against the steep cliffs that pkcrafter mentions.
Unfortunately, an index fund will not help protect you in a market decline. The total stock market index is 100% stock and will faithfully track the market wherever it goes. Your only defense against a full market fall is to own a parachute (some bonds and cash) and to be fully diversified. But don't conclude from this that index funds are not excellent investment choices, they are.
When I think of a cliff, as opposed to a dip, I think of stock in a particular company and they just fell off the cliff (no returning). So, I was saying that index funds will help protect you against that (i.e. avoid putting all your eggs in one basket). Because if the whole index (e.g. Total Stock Market Index) drops off a cliff for good, the world just ended. :shock:

So, if your cliff was just a steep drop and it was coming back (a big dip), I agree, index funds are just as capable of going down too.
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Post by tadamsmar »

livesoft wrote:I thinking buying on dips is not like flipping a coin. The reason is that when you buy on a dip, you already know what the outcome of the coin flip was.

To expound on this some more. If you are going to invest every month, you can have a simple rule: Invest on a day when the market is down by 1.5% or more, but if one does not occur invest by the end of the month.

The proverbial studies show that if you miss the 10, 20, ... N worst days in the market, then you come out way ahead. It is easy to know which day is a worst day becaue the news media tells you continuously throughout the day. All you have to do is invest within 10 minutes before the stock market closes. Any cash that you invest on such a day has missed one of the worst days. You know what the coin toss was by the time you invested: it was down.

Conversely, if one is going to rebalance out of equities, then do so on a best day. You will know which day is a best day because the news media tells you continuously throughout the day. All you have to do is sell within 10 minutes before the stock market closes.
Malkiel has reported that markets have a little bit of momentum, not enough to exploit, given the fees.

Any momentum will work against your scheme.
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Post by buyza »

By fees do you mean cost to trade?

I DCA, and typically buy only on big down days, if not always.

About 2 months back when I was curious to see how it was playing out vs lump sum investing, and investing at the same time every month, I came out with roughly a 4% return over lump sum, and 1.75% over 1st of every month.

I know 2-4% is not a huge deal in the long run to some, but the way I figure it is like this.

2000 - 4000 dollars (the amount I saved) over the course of 40 years (the amount until I retire), receiving 10% annually, will be worth an additional 90-180,000 when I cash it out. Not exactly pennies.
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Post by tfb »

grayfox wrote:If you bought yesterday at 1453 and it drops on Monday to 1350 and I buy, I will have a greater return than you forever after no matter what the market does. No forecasting or modeling is necessary to prove it. It is just arithmetic.
I agree. If you are buying at all, buying on dips is better than buying on peaks. The market may drop further after the dip, but the person who bought on dips will have a smaller loss than the person who bought immediately before the dip. That's just math. The only strategy that will save the investor from the loss is not buying. But we all know that's market timing.

The downside of "wait for a dip or end of month" strategy is that there may not be a dip during the month. The end of the month may turn out to be a peak. You may catch a dip or two, at the cost of buying on peaks many times. Or by the time the dip comes, the price is already higher than that at the beginning of the month. It's a dip if you look at only one day but it's a peak if you look back to the beginning of the month.

EDIT: Added clarification.
Last edited by tfb on Mon Nov 12, 2007 11:08 am, edited 1 time in total.
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Post by tadamsmar »

buyza wrote:By fees do you mean cost to trade?

I DCA, and typically buy only on big down days, if not always.

About 2 months back when I was curious to see how it was playing out vs lump sum investing, and investing at the same time every month, I came out with roughly a 4% return over lump sum, and 1.75% over 1st of every month.

I know 2-4% is not a huge deal in the long run to some, but the way I figure it is like this.

2000 - 4000 dollars (the amount I saved) over the course of 40 years (the amount until I retire), receiving 10% annually, will be worth an additional 90-180,000 when I cash it out. Not exactly pennies.
So, you are finding a point in the month were the market is 1.75% down vs the 1st of the month.

Your 2 month test was in a choppy market.

Try it in an uptrending market.
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Post by buyza »

tadamsmar wrote:
buyza wrote:By fees do you mean cost to trade?

I DCA, and typically buy only on big down days, if not always.

About 2 months back when I was curious to see how it was playing out vs lump sum investing, and investing at the same time every month, I came out with roughly a 4% return over lump sum, and 1.75% over 1st of every month.

I know 2-4% is not a huge deal in the long run to some, but the way I figure it is like this.

2000 - 4000 dollars (the amount I saved) over the course of 40 years (the amount until I retire), receiving 10% annually, will be worth an additional 90-180,000 when I cash it out. Not exactly pennies.
So, you are finding a point in the month were the market is 1.75% down vs the 1st of the month.

Your 2 month test was in a choppy market.

Try it in an uptrending market.
I said I did it 2 months ago, not in accordance with the last 2 months. If I did it now, im sure it would look even better. My test was for about the previous 6 months (april - september I think). April - july was an uptrend market, where my returns were still about .20% higher (july - september is where I made the largest gains).

When I go to my GF's tonight, I will see if I still have it on her computer so I can post it.
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Post by jh »

...
Last edited by jh on Thu Jan 17, 2008 4:23 pm, edited 1 time in total.
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drjdpowell
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Re: Buying the dips: neither good nor bad, it seems to me

Post by drjdpowell »

nisiprius wrote: Apply this to an efficient market in which the market price is a random walk around some underlying trend.
Hi nisiprius,
You are correct in your reasoning. "Buying on the dips", as a strategy, assumes that the market must be inefficient, with periods of under/overvaluation. If the market is efficient, all price changes reflect new information that rightfully indicates changes in true value, such as your car example.

-- James
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United
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Post by United »

Buying the dips will not increase returns, assuming a random walk model, or even a momentum model (the concept of market efficiency is irrelevent here).


If you buy on dips...

Usually you will do slightly better.

A few times you will do horrendously worse.

On average, you will do worse.



This type of outcome dispersion is similar to martingale betting systems, a common gambling fallacy.

It's totally irrational to conclude that your expection is positive simply because buying on dips does better most of the time. The magnitude of the results are just as importatant as the frequencies. The few times that buying on dips loses, it loses a boatload, offsetting all of the small gains.
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Post by nisiprius »

United wrote:Buying the dips will not increase returns, assuming a random walk model, or even a momentum model (the concept of market efficiency is irrelevent here).


If you buy on dips...

Usually you will do slightly better.

A few times you will do horrendously worse.

On average, you will do worse.

This type of outcome dispersion is similar to martingale betting systems, a common gambling fallacy.

It's totally irrational to conclude that your expection is positive simply because buying on dips does better most of the time. The magnitude of the results are just as importatant as the frequencies. The few times that buying on dips loses, it loses a boatload, offsetting all of the small gains.
That's interesting. I'd seen what looked to me like parallels to martingales in a number of investment systems... notably "keep a 2-3 year cash reserve to live on while you wait out a bear market..." but I hadn't thought of "buy the dips" that way.
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Post by livesoft »

Everyone who is happy that they didn't buy at the beginning of November, please raise your hand!
buyza
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Post by buyza »

Well for my personal experience in the last month and a half or so I have increased my portfolio by roughly 30%.

From what I spent, I saved an overall 9% off the 52 week highs (the majority coming in october, and a few at the start of november), and from what I spent, I am only down 2 1/2 - 3%. Half of that being on EM, which I was up 13% on just a week or so ago :( All of this not including the 10% I earned off buying in August. I was up about 15% however.

So yes the market has dipped more since I bought, and as I buy more, but I am pretty comfortable in my position. Especially with still having 50% of my money as cash on hand due to DCAing. Allowing me to further by into the market should it drop.

In the extremely long run 3% is a small price to pay to be in on a market 12% off its high.

I of course understand that these past few months have been less than ordinary and will not coincide with most drops in the market.
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Buying on Dips backtest using S&P500

Post by Eric White »

Hey everybody,

I took a previous poster's advice and took a crack at backtesting buying on dips.

Here's the file:
Buying on Dips backtest using S&P500, updated 2007-11-12, v5 with expanded thresholds

Assumptions:
- Monthly DCA at end of month
- DCA at different time frequencies not investigated (e.g. biweekly)
- Dip threshold = 1.5% (see expanded results for other thresholds)
- Can only buy once per month on a dip; this early opportunity buy prevents standard monthly DCA buy
- Daily data pulled from Yahoo Financial; only available through 1/2/62
- Does not consider other asset classes (e.g. fixed, stable value, REITs, etc.) or equity subclasses (e.g. LV, MB, MV, SB, SV, UB, UV, commodities, etc.)
- History only provides us one (1) seed for the series; multiple random seeds have not been tested for robustness

Results:
- 1.5% threshold is fairly frequent --> 550 monthly investment data points; buying on dip opportunities occurred 220 of 550 months (40%) ***THRESHOLD SIZE IS DIRECTLY CORRELATED WITH DIP OPPORTUNITY FREQUENCY
- Cumulative improvement = 0.08% :roll: ***SEE EXPANDED RESULTS FOR THRESHOLD SENSITIVITY
- Absolute change from monthly DCA shrinks as a function of time (including both improvements :( and disasters :D )

Expanded Results (threshold on left, change relative to monthly DCA on right):
0.00% 0.12%
-0.25% 0.06%
-0.50% 0.02%
-0.75% -0.02%
-1.00% -0.01%
-1.25% -0.07%
-1.50% 0.08%
-1.75% 0.00%
-2.00% 0.03%
-2.25% -0.01%
-2.50% 0.05%
-2.75% 0.00%
-3.00% 0.01%
-3.25% 0.04%
-3.50% 0.03%
-3.75% 0.03%
-4.00% 0.03%
-4.25% 0.03%
-4.50% 0.03%
-4.75% 0.03%
-5.00% 0.03%

Thoughts:
- The expanded results do not seem statistically significant.
- The nominal result of 0.08% for the -1.5% threshold seems to be very sample dependent considering the variation of expanded results by threshold. Apparently using the -0% threshold and simply changing from the end of the month to the beginning is the best of the dip strategies :wink:
- The most intriguing result for me is the reduction in absolute effect as a function of time. I personally believe this is most directly related to the fact that earlier in the time series small cumulative capital invested is more sensitive to daily changes on returns. However, I would be interested to hear the forum's interpretation of this trend. Please see the chart in the second tab to see this curve displaying exponential decay.
- I would like to understand United's post about martingale betting systems and how they can improve or invalid backtesting as a means of stress testing assumptions.
- I would like to understand how people familiar with Value Averaging compare this backtest result to other VA backtests. Is there a way to compare apples-to-apples?

Thanks! I look forward to everybody's feedback!

Given the lack of statistical significance, I've probably wasted too much time on this as it is. :evil: Oh well, you don't know until you can prove it to yourself, I guess.

Cheers,
Eric
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Post by TheEternalVortex »

It isn't accurate to have DCA at the end of the month be the normal strategy. If the money is available at any point during the month then you would invest it at the beginning. Which is why your "invest the first of the month" wins--investing earlier is better most of the time.
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Post by livesoft »

Hey Eric, thanks so much for the very nice backtesting. -livesoft
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My pleasure

Post by Eric White »

livesoft,

My pleasure! I was surprised by the data. I expected buy on dips to be more effective. Goes to show that intuition needs to be validated with data.

It makes me wonder if my confidence in value averaging needs confirmation as well. Of course, I'm stuck in paralysis with regard to value averaging due to this fear. Apparently only DCA'ing and staying fully invested was the appropriate first response.

Cheers,
Eric
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Re: Buying on Dips backtest using S&P500

Post by House Blend »

Eric White wrote:I took a previous poster's advice and took a crack at backtesting buying on dips.
Very interesting.

Given that the investor has the option of investing at any point during the month, I think the natural assumption is that the money is parked in a MMF. In that case, there is an extra penalty that the early dipper pays--the loss of interest that would have been earned by the MMF.

The value of one week's worth of earnings from a MMF yielding 5% is about 10 basis points, which threatens to overwhelm the nominal advantage that your calculation shows. Of course MMF's have been known to earn far less than 5%, but I notice that Vanguard's Prime MMF has earned a whopping 6.47% annualized since inception in 1975.

Is there a way to look up historical yields on MM funds? Yahoo Finance doesn't seem to have that information.
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Post by livesoft »

How about testing another hypothesis as well? Suppose I have money parked in an emergency fund that I can tap to invest or leave as my 6 months expenses. Now when the market dips by 1.5% (or n%), I invest 'ahead' two (or 1 or 3) months worth of monthly DCA contributions by tapping my e-fund. If I have invested ahead, my next (2, 1, 3) DCA contribution has to go back into the emergency fund to build it back up.

Now this is blatent market timing with one's emergency fund and some folks will be aghast.
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Post by grayfox »

The strategy buy-on-a-dip or at the end-of-the-month-if-no-dip is not any kind of strategy I would ever use. The reason is because with this strategy you must buy every month, no matter what the price. With this strategy you will be buying at the top of a bubble if that is when you have money.

In my opinion nobody ever has to buy anything. The key to getting anything at a good price is being willing to walk away. The people who bought tract homes in Santa Ana, CA for 850K felt they had to buy and were unwilling to walk away.

My strategy is to only buy when a return hurdle is met. If I require 2.5% and the expected return is currently 1.8% then I don't buy. My goals will not be met at 1.8% So before buying, there will have to be a dip in the price.

Does this strategy sound familiar to anyone?
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Post by HockeyMike35 »

TheEternalVortex wrote:It isn't accurate to have DCA at the end of the month be the normal strategy. If the money is available at any point during the month then you would invest it at the beginning. Which is why your "invest the first of the month" wins--investing earlier is better most of the time.
BINGO! That is exactly what I was thinking. This comment seems to be being ignored but it is important. It makes the study completely invalid IMO. The discussion was about someone who invest as they get the money or someone who WAITS for a dip. The DCA will invest their money sooner not at the end of the month.

Mike
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Post by nisiprius »

HockeyMike35 wrote:
TheEternalVortex wrote:It isn't accurate to have DCA at the end of the month be the normal strategy. If the money is available at any point during the month then you would invest it at the beginning. Which is why your "invest the first of the month" wins--investing earlier is better most of the time.
BINGO! That is exactly what I was thinking. This comment seems to be being ignored but it is important. It makes the study completely invalid IMO. The discussion was about someone who invest as they get the money or someone who WAITS for a dip. The DCA will invest their money sooner not at the end of the month.

Mike
Whoaaa... what's the difference between investing regularly at the end of the month and investing regularly at the beginning of the next month?

Something magic happens at midnight on the last day of every month that transforms a poor strategy into a good one?
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Post by House Blend »

HockeyMike35 wrote:
TheEternalVortex wrote:It isn't accurate to have DCA at the end of the month be the normal strategy. If the money is available at any point during the month then you would invest it at the beginning. Which is why your "invest the first of the month" wins--investing earlier is better most of the time.
BINGO! That is exactly what I was thinking. This comment seems to be being ignored but it is important. It makes the study completely invalid IMO. The discussion was about someone who invest as they get the money or someone who WAITS for a dip. The DCA will invest their money sooner not at the end of the month.
I can't speak for others, but the scenario I have in mind is that the investor is taking money out of his emergency fund to invest when a dip occurs prior to getting his paycheck. Then restoring money back to the emergency fund after the paycheck clears.

This is different from getting paid and then WAITING for a dip.

You can argue that one shouldn't (a)buse an emergency fund this way, or that you should invest as much of the emergency fund until you are no longer willing to play this game (plenty of diehards don't even have an emergency fund), but I don't accept that the premise is "invalid".

Also, to repeat from my first post in this thread, the extent to which I do or do not follow this strategy is not out of some conviction that it offers higher returns, but because it offers a way to distract my ego with something minor.
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Post by livesoft »

livesoft wrote:Everyone who is happy that they didn't buy at the beginning of November, please raise your hand!
Everyone who is happy that they did buy after the dips in the beginning of November, please raise your hand.

There is no way to know where the stock market averages are going to go either near term or intermediate term, but I am still enjoying 6+% one-day gains in emerging market ETFs.
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Post by tadamsmar »

House Blend wrote:
HockeyMike35 wrote:
TheEternalVortex wrote:It isn't accurate to have DCA at the end of the month be the normal strategy. If the money is available at any point during the month then you would invest it at the beginning. Which is why your "invest the first of the month" wins--investing earlier is better most of the time.
BINGO! That is exactly what I was thinking. This comment seems to be being ignored but it is important. It makes the study completely invalid IMO. The discussion was about someone who invest as they get the money or someone who WAITS for a dip. The DCA will invest their money sooner not at the end of the month.
I can't speak for others, but the scenario I have in mind is that the investor is taking money out of his emergency fund to invest when a dip occurs prior to getting his paycheck. Then restoring money back to the emergency fund after the paycheck clears.

This is different from getting paid and then WAITING for a dip.

You can argue that one shouldn't (a)buse an emergency fund this way, or that you should invest as much of the emergency fund until you are no longer willing to play this game (plenty of diehards don't even have an emergency fund), but I don't accept that the premise is "invalid".

Also, to repeat from my first post in this thread, the extent to which I do or do not follow this strategy is not out of some conviction that it offers higher returns, but because it offers a way to distract my ego with something minor.
http://www.ideosphere.com is a nice distraction. See if you can get ahead there.

Of course you are going to get a higher return if you invest your emergency funds in risker assets. No news there.
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Post by buyza »

livesoft wrote:
livesoft wrote:Everyone who is happy that they didn't buy at the beginning of November, please raise your hand!
Everyone who is happy that they did buy after the dips in the beginning of November, please raise your hand.

There is no way to know where the stock market averages are going to go either near term or intermediate term, but I am still enjoying 6+% one-day gains in emerging market ETFs.
Mmmmm I just came home to 7% one day gain on 75 shares of VWO. Just delicious.

2 1/2% on each VEA and VTI ain't bad either.

I think my true winner is DJP commodity index though, im up 75k.



And by K I mean C...ents :D
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Post by United »

This "strategy" is ridiculous. The only way it works is if there is a short-term mean reversion effect present in the markets. History says there is no such exploitable effect.


The reason investing on the first of every month is substantially different than investing at the end of every month is that the first strategy will have each dollar in the market for exactly one month longer. The expectation of investing for one month is not trivial. To properly backtest this strategy, you must have the lump summers invest at the beginning of every month, not the end. If they invest at the end, you should expect the dippers to win, simply because they invest earlier on average, not due to any higher returns caused by buying on dips.


Please answer the following questions: why use the month as your timeframe? A month seems very arbitrary to me. Since the month has no inherent difference than any other time interval, does that imply that the buy on a dip strategy would work for any inverval (such as minutes or years)? Similarly, 3% or whatever dip threshold you choose has no inherent specialness either. So would you expect this strategy to outperform if it bought on 0.1% dips? How about on 40% dips?
Eric White
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Looking for constructive strategy testing

Post by Eric White »

House Blend wrote:
HockeyMike35 wrote:
TheEternalVortex wrote:It isn't accurate to have DCA at the end of the month be the normal strategy. If the money is available at any point during the month then you would invest it at the beginning. Which is why your "invest the first of the month" wins--investing earlier is better most of the time.
BINGO! That is exactly what I was thinking. This comment seems to be being ignored but it is important. It makes the study completely invalid IMO. The discussion was about someone who invest as they get the money or someone who WAITS for a dip. The DCA will invest their money sooner not at the end of the month.
I can't speak for others, but the scenario I have in mind is that the investor is taking money out of his emergency fund to invest when a dip occurs prior to getting his paycheck. Then restoring money back to the emergency fund after the paycheck clears.

This is different from getting paid and then WAITING for a dip.

You can argue that one shouldn't (a)buse an emergency fund this way, or that you should invest as much of the emergency fund until you are no longer willing to play this game (plenty of diehards don't even have an emergency fund), but I don't accept that the premise is "invalid".

Also, to repeat from my first post in this thread, the extent to which I do or do not follow this strategy is not out of some conviction that it offers higher returns, but because it offers a way to distract my ego with something minor.
House Blend, Mike, & Vortex:

Please confirm whether you are talking about Value Averaging or a different strategy. To me, you are simply describing Value Averaging. As noted in the post, the forum needs a way to compare "buying on the dip" as a TACTICAL manueveur in comparison to Value Averaging as a strategy competing with DCA.

BTW, I can rework the model if you really want day 1 to appear at any point throughout the month. I highly doubt it will change the results, however, especially after integrating money market interest for the holding period. :roll: Please post your results or keep the comments constructive, one or the other.

grayfox wrote:The strategy buy-on-a-dip or at the end-of-the-month-if-no-dip is not any kind of strategy I would ever use. The reason is because with this strategy you must buy every month, no matter what the price. With this strategy you will be buying at the top of a bubble if that is when you have money.

In my opinion nobody ever has to buy anything. The key to getting anything at a good price is being willing to walk away. The people who bought tract homes in Santa Ana, CA for 850K felt they had to buy and were unwilling to walk away.

My strategy is to only buy when a return hurdle is met. If I require 2.5% and the expected return is currently 1.8% then I don't buy. My goals will not be met at 1.8% So before buying, there will have to be a dip in the price.

Does this strategy sound familiar to anyone?
grayfox,

Unfortunately, this strategy does sound familiar. It sounds to me like P/E market timing. I'm sure other Diehards on this forum can provide Monte Carlo stress-tested results for that backtest, and it ain't pretty.:oops:

Value tilting and Value Averaging may have their place, but it looks like:
- "buying on dips" is pretty ineffective/moot
- Value Averaging has the edge over "buying on dips" because it captures momentum over a strategic length of time instead of riding the return to mean in both directions
- P/E market timing is a high-risk way to get appropriate asset allocation with a value tilt.
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Lack of constructive posts is getting tiresome

Post by Eric White »

United wrote:This "strategy" is ridiculous. The only way it works is if there is a short-term mean reversion effect present in the markets. History says there is no such exploitable effect.


The reason investing on the first of every month is substantially different than investing at the end of every month is that the first strategy will have each dollar in the market for exactly one month longer. The expectation of investing for one month is not trivial. To properly backtest this strategy, you must have the lump summers invest at the beginning of every month, not the end. If they invest at the end, you should expect the dippers to win, simply because they invest earlier on average, not due to any higher returns caused by buying on dips.


Please answer the following questions: why use the month as your timeframe? A month seems very arbitrary to me. Since the month has no inherent difference than any other time interval, does that imply that the buy on a dip strategy would work for any inverval (such as minutes or years)? Similarly, 3% or whatever dip threshold you choose has no inherent specialness either. So would you expect this strategy to outperform if it bought on 0.1% dips? How about on 40% dips?
"Buying on dips" is not a strategy. It is a tactic used within a strategy like DCA or VA. This particular backtest simply took a look at "buying on dips" within DCA. "Buying on dips" outside of DCA is effectively VALUE AVERAGING.

The only reason I chose one month is that I could relatively quickly build the model with a short enough duration that mimicks the way many people get paid (e.g. monthly, biweekly, etc.) while avoiding the need to build cash reserves between pay periods like VA requires. If the investor sees an opportunity in the short term before DCA needs to occur before the next pay period, I wanted to see if this was meaningful in any way. The results, per the prior post, do not seem statistically significant.

I only showed the expanded results with various thresholds to demonstrate lack of statistical significance, not as a preferred strategy. You'd be waitin' a looong time for that 10% dip...

I will come back and respond when posters bring concrete results and subsequent constructive improvements to the thread. I would appreciate improvements to the model provided, a completely different model that provides more flexibility, or a rigorous academic paper that can validate/invalidate the previous findings.

For instance, United, I would really like to understand the Martingale process you were describing and if there is a way to use it instead of this brute-force method.
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