Trading Strategy: Buying Dips
This is an effective strategy for all types of financial instruments. It works best when there is a clear bullish market. It involves buying into an established uptrend, and it tends to exit before the trend is finished,so it doesn’t capture the whole trend, but as a result tends to be less risky than trying to do that. The steps involved are –
- establish that the market is going up
- check that the sector is going up
- make sure the particular financial security is going up
At this stage, you would put the financial security on your watchlist. While you could place a trade on it, hoping that the trend will continue unbroken, as we have seen trends tend to advance in stages, periodically having setbacks or consolidations before continuing. In this case you are waiting for the consolidation to occur, which should mean that the uptrend, newly refreshed, will advance for a time.
- wait for a short-term dip or retracement in price
- wait for the short-term dip to end
- calculate trade size and stoploss
- enter trade long
- exit trade if failed or on profit
First confirm the upward trend by long-term moving average, or by looking at the charts if it is obvious. The short-term dip can be defined as the daily low being less than the previous two days’ lows, or you could use an indicator such as the RSI showing oversold for the last three days.
To determine when the dip has finished, look for the price to rise above the previous day’s high, showing that the uptrend has recommenced. The stoploss, or protective stop, should be placed below the lowest low of the last three days, as if this level is breached, the dip has not finished after all.
You may also wish to follow the retracement using the Fibonacci ratios to detect likely reversal levels. Look most frequently for a reversal and resumption of the trend when the retracement has been roughly one-third, one half, or two-thirds of the initial move. If the retracement is more than that, then it is really a trend reversal, at least at the moment.
You could exit the trade when the uptrend appears to be over, as signaled by a change in the moving average direction. Another possibility is to use a trailing stop.
For your risk/reward ratio, you may choose to use the length of the previous uninterrupted trend as a potential target; and the starting price of the previous trend, or a technical position as the stop loss or risk level. Make sure that you use the current entry price when making this calculation.
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