The following article was prepared for LeapRate by Giles Coghlan, Chief Currency Analyst at HYCM.
Why buying the dip is good for both your account balance and trading psychology
An important aspect of trading that many newcomers seem to have trouble with is the stress of taking a position in the heat of the moment. For many, it seems that they always narrow in on an opportunity just as it’s starting to move away from them. Then comes the big internal debate about whether to chase it or not. In theory, it is almost impossible to prepare for the anxiety caused by a fast-moving market that you want in on, and many beginners quickly come unstuck when trying to put what they’ve learned into practice. A common reaction to this tension is to jump in regardless, reasoning that if it’s going up anyway, it’s better to buy in now at whatever price rather than waiting for a better opportunity later and possibly missing out. In the following article, we’ll look at why this is a mindset that ought to be overcome.
As a retail trader, you have your work cut out for you in many ways. You’re probably trading with less capital than the professionals. You’re trading your own book rather than other people’s money, which also significantly increases the stakes and the pressure on you to succeed. To top it all off, institutions have teams of people responsible for the things you will have to do on your own. The strategists who decide on what trades to put on are rarely the same people responsible for getting those positions filled. Retail traders, on the other hand, are forced to wear both hats and many more.
This way of compartmentalising the individual skills that go into putting on a winning trade, also theoretically protects institutional traders from many of the cognitive biases that you’re prone to as an individual. It has to be partly responsible for the higher failure rate among retail traders, which is why if you’re serious about trading, at some point you will have to look at these weaknesses and start working on fixing them.
Compartmentalise
Compartmentalising is also why the scientific community has been so successful at overcoming the biases of its individual members. Every practitioner has their own limited niche of expertise and focuses on that, and not the bigger picture. You, on the other hand, probably have the bigger picture looming large over you while you’re trying to trade. If your next mortgage payment, or this summer’s holiday, or the possibility of a brand-new car will be affected by getting into a trade or not, then you’re bound to make mistakes.
It’s important to break down trading into its component skills as the professionals do and to know which hat you’re supposed to wear at what time. If the analysis and position-sizing have already been done, then you will know the levels you want to enter at and how much of your capital you’ll be allocating. Your job then is simply to get filled at or as close to those prices as possible; not to change the strategy along the way, not to conduct technical analysis on the fly at the 5-minute time frame, not to be chasing the market if you’ve missed the move or to be doubling down if you got in and it turned against you.
Those well-worn trading truisms like “buy the rumour, sell the news”, or even worse, “buy low, sell high” may sound dated, but they exist because they include some basic trading wisdom that most people still fail to heed. Likewise, “buying the dip” is both a cliché and an important note to self when you’re watching the price moving away from you.
Buy the dip!
It’s funny how we all instinctively know that what goes up must come back down; except when we’re watching a market that we’re hoping will climb. In these instances, for some reason it seems as if the only possible way is up; it must be now, or the opportunity will be lost forever.
A good recent example was this year’s gold rally. Gold hadn’t been all that interesting for a while as cheap money and a soaring stock market sucked capital into riskier assets like a whirlpool. Many had been on the sidelines watching gold trade in a range that goes back to 2013. They had also been observing negative interest rates and spiralling global debt, global geopolitical tensions, and isolationist trends, without being confident enough in the yellow metal, or their own abilities to “bet against the Fed.” It was only after gold decisively broke out of that range in June of this year, surging some 14% to highs beyond $1500, that suddenly everyone was talking about gold again.
If we put former resistance at around $1380, then it took a 15% run beyond this point and around 5 months for everyone to catch up. If, as the evidence has suggested, it really is a good time to buy gold, then you could have fooled yourself into thinking that it was an equally good time to buy gold in August 2019 with the price at $1525. By September the price dropped down to $1445, giving back more than 7% of the move. People do this to themselves all the time.
Learning to stop and wait for a dip to buy achieves two important things. Firstly, it lowers your risk. Markets don’t tend to go straight up; they consolidate following periods of growth and that consolidation can be as severe as retracing the entire move. What’s the worst that can happen if you don’t buy and there is no dip? It goes straight up, and you miss out on a great trade. You haven’t lost anything tangible in this scenario, just what you could have had. Lots of traders fail to grasp the distinction here or even to see that there is one. On the other hand, getting your timing wrong and buying at the top, even if it’s only a local top on the way to future all-time-highs, does cost you in a real way. It costs you the capital locked up in a losing trade, and even if it has good prospects in the medium- to long-term, that capital could have been used more productively elsewhere.
The second, less obvious thing that learning to buy the dip achieves is that it disciplines you as a trader in an important way. It’s very difficult to sit there and watch as something rises without you being on board when you could have been. Forcing yourself to accept these anxieties without acting upon them toughens you up. It helps make you a much less reactive trader and as a result, you avoid jumping haphazardly in and out of trades and needlessly churning your account. Also, once you start to get the hang of it, your body starts to learn how it feels to do something so contrary to its instincts and is much more willing to give you the leeway to wait for dips in the future without stressing you out.
It doesn’t matter what time frame you’re trading at, or how long you intend to hold your position, learning how to look for and capitalise on dips is one of those solid practices that can be applied across the board whether you’re scalping EUR/USD at the 1-minute time frame or taking a position in gold that you intend to hold for the remainder of the year.
Disclaimer: any opinions made may be personal to the author and may not reflect the opinions of LeapRate. This is not a trading advice.