Why We Shouldn’t “Buy the Dip”

“Buying the dip” is buy stocks whenever there is a short-term decline in stock prices, under the assumption that asset prices will quickly revert, enabling you to make money.

This article explains why a government-driven culture of “buying the dip” can be damaging to you and society at large.

Markets work best when people use fundamental analysis rather than prices or what they think is a guaranteed pricing pattern to allocate capital. When there is no fundamental analysis the markets become a casino and instead of the best companies getting more capital than the worst companies getting less, this money is randomly (or by the best Reddit meme) distributed which means that the best companies get less money and the worst companies get more than they would in a fundamentals-based market, which ultimately means this money is less efficiently used (because the best company spend money better) which is bad for society.

Since 2009, you made money buying the dip. That’s 14 years now, where every time you didn’t buy the dip, you lost money and saw friends make it. The government has been instrumental in this, doing multiple rounds of “quantitative easing” and cutting interest rates simply because markets didn’t like it (see the “tamper tantrum” of 2018). Equity purchasers have been trained by this 14 years of pricing behavior and government’s support of it. So why is it a problem? It’s a problem because at some point the government will not be able to reverse a real (not nominal) decline in asset prices and when that happens the people who bought the dip don’t see a small decline in their worth; they get massively wrecked, Great Depression style. Why? Two reasons: a) with every success dip, people bought more and harder because they saw it work consistently b) more and more people bought the dip so when it didn’t follow its normal behavior the dip dipped harder than anyone had ever seen before. So the dip-buyers get wrecked harder than they could imagine, causing economy wide panic when they were counting on their dip buying profits for other purchases & bills.

A government driven culture of buying the dip persisting for 14 years sustains asset prices and contributes to the idea that stocks never go down, second order effects of which are damaging to society. Two examples: a) because of an erroneous belief that stocks never drop over the long term and that this is sustainable, government pensions over allocate to stocks and don’t consider what they consider to be black swans of this not being true, a bit like banks, just a few months ago, considered the possibility of higher interest rates and customer withdrawals to be a risk not being a risk worth insuring against. b) people stop building products and start focusing on asset trading because it’s a better way to make large sums of money. Look at twitter, for example, there are countless smart people focused on asset creation and trading instead of the creation of new products. Why is this an issue? It’s a problem because asset creation and trading doesn’t improve peoples’ lives, new technology and efficiency improvements do, but, because stocks always go up, even these things, become disconnected from asset prices, further disincentivizing their development, which again, is bad for society. Further, these people, some of the smartest and most well educated, when this consistent persistent buy the dip sustained high asset price phenomenon ends and we have a period of 10-20 years when asset prices decline or are flat in real terms, will be useless to society because instead of learning how to build a car, they learned only on how to bet on the race, a total misallocation of society’s true greatest asset, not stocks, but human capital.

So in summary, a government driven culture of buying the dip is bad for society because:

1. Good companies get less money than they deserve, bad poorly run companies are allocated more capital which they spend inefficiently

2. The people who buy the dip ultimately get wiped out in a way they wouldn’t if we had a series of smaller declines than one massive one caused by this government driven behavior

3. It causes second order effects like brain drains to inefficient unproductive sectors of society.