Dip buying. Those dirty little words.

Buying dips. It’s almost a dirty word in investing circles. As many of you know on my previous blog I wrote extensively on that subject and tracked a real-time portfolio of swing trades (1-10 day holding period) that were always entered at the open of the next trading day. The system itself was part of dip buying strategy that had tested very well on baskets of stocks during virtually any market condition I tested it against. This portfolio had done extremely well in the year that I tracked it in real-time for you on on that blog. The archives of that blog are full of trades for your review.

The base elements of that system were the ability to recognize stocks that were volatile, had some previous strength, plenty of liquidity, previous volume bulge, and most recently strong directional weakness. But the absolute key elements of trading a system like this is to trade with a portfolio that can expand and contract it’s number of holdings based on the waves of strength and weakness in the market.

In other words your exposure level. If buying dips is the secret to success in swing trading the market then exposure is the holy grail. If the market as a whole is at a 6 day RSI of 80 and I have a 10 position portfolio, and I have 4 open slots available in that portfolio, should I add the 4 buy signals I have in todays scan? Essentially going to 100% exposure. If you were to test market performance a few days after a 80 RSI reading I can assure it is less than those of readings below that in a very broad general sense. So why pile in? If you are trading stocks that are of a recent volatile nature it will not be necessary to be fully invested to keep up with the market because your portfolio essentially is more volatile than the market as a whole. If the market were to selloff the next few days then you have some ammunition left to add positions as the market drops and look for the eventual strength to unwind positions. Having backtested literally thousands of variations of swing trading systems I can say unequivocally the secret is exposure. Always, always, always be aware of where the market is in its present wave and where your exposure level is in your swing portfolio in relation to that.

The other essential element of being able to survive the inevitable dip that becomes a full fledged big loss is to have enough portfolio slots that one bad trade does not ruin long term performance. On the blog I used a 5 position portfolio and in reality this was being quite aggressive. Something closer to 7-10 would be the minimum I would recommend. This will allow you the ability to expand and contract exposure effectively with the markets waves. If you browse the Wealth-Lab site you will see people mentioning dip buy disasters. There should be no disasters if each holding is only 1/10th of your portfolio. If a stock zooms down 30% in your holding period then this is “only” a 3% hit to the swing portfolio. Not too bad and you live to fight another day.

This now leads to the next inevitable question “why would you let a stock drop 30% ?” My answer to that is “where would you put your stop?” I am here to tell you from my extensive backtesting experience there is no stop level that does not adversely affect swing trading performance. None. I know that flies in the face of conventional wisdom. But I am entirely confident in that statement. John had written a bit about that last year. Ultimately the way to keep disasters from being disasters is to be properly diversified in your swing holdings. And wait for the eventual timeout or strength exit.

So although buying dip can be that dirty word I spoke of the key is to apply some of the principles I mentioned here to help you consistently outperform during most of the markets up and down waves. Not all of them but enough so that you have and edge. And an edge is all I am looking for.

Have a Great Weekend!

Dave Johnson