Stocktake: Buying the dips beats buying into momentum

It’s human nature to feel optimistic when markets advance and pessimistic when indices slip. However, active traders would be much better off buying the dips instead of buying momentum, according to Bespoke Investment.

Bespoke went back to 1993, when traders were first able to buy the SPY exchange-traded fund (ETF) that tracks the S&P 500. Over that period, you’d have bagged gains of 740 per cent if you bought the ETF the day after down days. However, if you’d bought the fund on the day after an up or flat day, you’d have gained only 10 per cent.

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Momentum traders did even worse if they bought the index following big up days where it gained at least 1 per cent. Doing so would leave you with cumulative losses of 50 per cent. In contrast, those who held their nerve and bought after big down days were rewarded with cumulative gains of 350 per cent.

Bespoke’s data isn’t actually an argument for active trading. Firstly, it doesn’t include commission costs. Secondly, buy-and-hold investors still did better than the dip buyers. However, it seems that if you are going to actively trade the markets, you’re better off buying the dip rather than buying momentum.