Here’s the Latest Batch of “Buy the Dip” Winners

By: Wayne Duggan

There has been a major turn in the tides of some of the worst-performing stocks in the market over the past couple of days. Traders with a “buy the dip” mentality have been rewarded for their courage, but buy-the-dip trading can be a dangerous game.

Buy the Dip Winners
Here’s a look at five stocks that have taken a beating in the past month along with their one-month returns:

  • Skillz Inc (NYSE: SKLZ) -32.3%
  • Opendoor Technologies Inc (NASDAQ: OPEN) -32.8%
  • FuboTV Inc (NYSE: FUBO) -35.3%
  • Discovery Communications Inc. (NASDAQ: DISCA) -49.9%
  • ViacomCBS Inc (NASDAQ: VIAC) -57.1%

However, those five stocks have all made 180-degree turns in the past two days:

  • Skills: +36.5%
  • Opendoor: +11.8%
  • FuboTV: +8.5%
  • ViacomCBS: +8.3%
  • Discovery: +7.6%

Why Does Buy the Dip Work?
There are multiple reasons why buying the dip can be a viable trading strategy. The first explanation is that the stocks in question actually become undervalued based on their fundamentals. Stocks often get overextended or oversold in the short term due to upward or downward momentum. They will overshoot their equilibrium point before correcting back in the opposite direction.

Value investors use metrics such as price-to-earnings ratio, price-to-sales ratio, price-to-free cash flow ratio and price-to-book ratio as a means of determining whether or not a falling stock has become undervalued relative to its underlying business. 

Another reason dip buying works is because sellers temporarily become exhausted. The lower the stock price goes, the less appealing it is for additional investors to dump their shares. Short sellers may even start buying back shares of the stock to cover and exit their positions. 

Traders use technical metrics such as relative strength index (RSI) to determine whether or not a stock has become oversold in the near term. RSI is a momentum oscillator that ranges from 0 to 100. Traders typically consider a stock with an RSI of 30 or below to be “oversold” and a potential buy the dip trade.

Buy the Dip Risks
Before buying any stock on the dip, traders need to first ask themselves why the stock dropped in the first place. Obviously, a stock that drops 25% in one day because it announces bankruptcy is probably not a good buy the dip candidate. There’s a good chance that stock will continue dropping all the way down to $0.

And even if a falling stock does eventually bounce, it can be difficult to time the bottom. If a stock bounces from $50 to $60 after dropping from $100, traders that “bought the dip” when the stock was at $75 still got burned badly on the trade.

The author holds no position in the stocks mentioned.

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