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Buy The Dip On The Decline

Buy the dips has been a profitable simple strategy this year but its effectiveness is now on the decline after topping in February of this year. Often a top in this strategy is followed by a short-term correction due to accumulated momentum.

As shown in the daily SPY chart below, the percentage of down days followed by up days in a 252-day rolling window topped in February of this year around 67% and since it has been on the decline, falling below 60%.

Usually, but not always, a decline in buy the dip activity is associated with a short-term top or even a major top as in 2007. It may be been that the dynamics of the market after the dot com bear market have changed and this impacts inferences from studies of price action. In other words, the change in dynamics from the 1990s has impacted price action analysis in a fundamental way. For example, buy the dip activity bottomed near the 2000 top instead of topping. This is one reason that any claims about future performance based on results before the 2000 top are in most cases invalid. This applies not only to the relation of buy the dip to the formation of tops but to everything, including hedge fund and CTA performance. We are talking about completely different price action dynamics after the 1990s.

If the current downtrend in buy the dip activity continues with the number of down days followed by up days decreasing, it is then only natural to have a correction due to accumulated momentum. The process may be slow as it is reflexive in nature because traders cause reversals by buying dips and in turn the occurrence of dips motivates more traders to buy dips.

The stock market is probably near a short-term correction mode but no one can know the magnitude and exact timing. It is highly likely that the next correction will also be seen as a buying opportunity.

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Charting and backtesting program: Amibroker


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