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Claims that Buy the Dip is New Phenomenon or that it no Longer Works Are False

On February 7 Bank of America (NYSE:BAC) argued in favor of a bullish case after an 8% pullback. But yesterday, the same bank argued that the popular buy the dip strategy is no longer working.

What is happening here?

It’s hard to know the details but it seems these two apparently conflicting views may have been generated by different departments. It is also impossible to imagine that the conclusion about the recent ineffectiveness of the buy the dip strategy was made based on one month’s data.

What is more interesting about the report yesterday is that they are talking about buying 5% dips in S&P 500 futures and holding until retracement or for maximum of 20 days. I wonder how many stock investors trade S&P 500 futures, or even E-mini futures. Most will use an ETF that tracks those indexes. The reference to S&P 500 futures is peculiar. But then, all these years I have come to the conclusion not to pay any attention to analysis from large investment banks since it is for all practical purposes random. If you want to succeed in trading and investing you have to learn how to do your own analysis. This is what we do in this article.

I have tested the buy the 5% dip strategy mentioned in the more recent article in SPY (NYSE:SPY) ETF with daily data since 2010, as shown in the chart below:

The chart includes the buy and hold performance the underwater equity curve and the equity performance of the strategy. The green arrows indicate entry points, or buying the dip, and the red arrows the exit points. It is obvious that this is not an investment strategy but a way of adding to positions since performance is low. The annualized return for the strategy is 3.34% versus 13.11% for buy and hold in the period considered. I have no idea how BAML concluded that since 2014 the strategy has outperformed buy and hold. Probably that had to do with futures leverage and shows how results depend on various assumptions that do not apply to everyone. Unless these assumptions are stated, the public can get the wrong idea but the race for click-bait is so competitive that these details become irrelevant.

In 2018 there is one trade and the return is 5% based on the strategy specifications. I again have no idea why they say this strategy has stopped working in 2018. And then they talk about the implications of the collapse of the strategy that “are wide-reaching and could reshape the markets.” These words do not make sense to me and also the rest of the analysis mixing the Fed, volatility and corporate reports. Buy the dip is nothing new; it has existed as long as markets have existed. If we repeat the same backtest as above in SPY data since inception, we see that buy the dip was even more prevalent in the 1990s and even 2000s.

I have no idea how these analysts reached their conclusions that buy the dip is something new that was caused by some Fed policies or otherwise. Buy the dip has been a common strategy for many years and it is nothing new. The moral of the story is that there is a lot of noise in the financial media due to competition for clicks.

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If you have any questions or comments, happy to connect on Twitter: @mikeharrisNY

Charting and backtesting program: Amibroker


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