Understanding "Buy The Dip"

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What is buying the dip?


In the stock market, share prices regularly fluctuate. This doesn’t affect the amount of shares you own but instead the value of the shares. Usually when these fluctuations happen, depending on the reason, share prices may drastically drop, resulting in an opportunity to “buy the dip”.

This enables investors to reduce the purchase average. For example:

  1. You buy 200 shares (batch one) @ R1
  2. You buy another 500 shares (batch two) after the share price drops to 50c per share

Instead of having two different holdings, batch one and batch two are combined and you are given a purchase average for your holding in the specific company.

The formula used (excluding costs)

(200 x 1) + (500 x 0.50) = 450

The total value of the holding (450), divided by total number of shares (700) = R0.64: the average share price

The more shares you buy relative to the initial holding, the more the purchase average moves closer to the trading price, or the price for which you purchased the new shares.

Is a dip in a share price always a bad thing?

The reasons for share price dropping may differ from time to time. This doesn’t mean that a drop in share prices makes for a “bad investment”.

Sometimes these drops, or dips, can be because a company is not performing well. Other reasons may include:

Share dilution

Dilution of shares occurs when a company issues additional shares, resulting in a reduction in value of existing shares. This usually occurs when a company is raising additional capital.

Read more on share dilution here or below
Share dilution

Sell-off

In terms of supply and demand, when the supply exceeds the demand of a specific share, this may result in a dip. The size of the dips may differ depending on the volume of shares sold during the period.

Importantly, buying the dip is focused on capitalising on the short-term fall of a share price for long-term gains while taking into consideration the fundamentals and directions of a company.

Read more on what happens when a company delists here or click below 

Delisting

 

 
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