Break the Buy the Dip Habit

'Buying the dip' - investing new money after stock market declines - has been profitable for almost a decade. However, Chicken Little believes that buying the current dip will be disastrous (see, Chicken Little sees death). Keeping our money safe, however, requires overcoming our own brains.

Don't Buy this Dip 

This post has three parts.
1. Stocks are on sale -- many people will buy the dip.
2. Our brain makes us want to buy the dip. 
3. Our brain is not good at investing. 

1. Stocks are on sale. 

Time to go shopping?

The stock market has dropped 10% from its high on January 26, 2018. Some people see price declines as "discounts" from previous higher prices. The table below shows that some famous stocks sell at discounts close to 20%. 

current level (March 22, 2018)
recent high
% 'discount'
Dow Jones Industrial Average23,958.0026,616.719.99%
Google $1,049.00$1,198.0012.44%

People love a good discount. In fact, earlier this month, investors "pumped the most money ever into stock funds for a single week" (click for more)

2. Our brain makes us want to buy the dip. 

Why do we like to buy when the stock market goes down? The short answer is that every dip has been a buying opportunity since March 9, 2009. The longer answer is that inside our brains, we have sophisticated, learning mechanisms that influence our behavior. These learning mechanisms are ancient and powerful. Let us take a moment to see how we learn. 

First, our brains make us deeply unhappy when we have bad outcomes. For example, in Top Gun, Tom Cruise's character Maverick loses one of his fighter school competitions because he leaves his wingman. After losing, and being yelled at for his violation of sacred tactics, Maverick swears he will never leave his wingman. (click for Top Gun Scene)

Second, our brains reinforce behaviors that lead to success. We learn to repeat behaviors that have good outcomes. Furthermore, we know exactly how this systems works. When something good happens (e.g, food, sex, money), our brains are flooded with dopamine. The dopamine makes us happy, and it makes us want to repeat the behavior that worked. 

Staying with the movie theme, recall how Rocky Balboa felt good as his workouts became more proficient (caution: don't click on this link unless you have 15 minutes to get pumped up). 

Rocky enjoying a dopamine cocktail

Our brain is built to learn. Dopamine guides us back to successful behaviors. Conversely, unhappiness after failure causes us to avoid repeating the losing actions. 

3. Our brain is not good at investing. 

On March 9, 2009 the Dow Jones Industrial Average closed at 6,547.05. On January 26, 2018 the Dow hit 26,616. 

The Dow rose 20,000 points over almost a decade. Our brains are not stupid. They have learned the lesson. Never sell stocks. Even better, buy the dips. Every risky purchase of stocks since 2009 has earned investors money and dopamine.

Buying Stocks has been awesome

Earlier this month, I took my first short position in stocks in years (click for article). I wrote one of my investors friends, "(I am) Like a beaten dog -- literally. For almost a decade, every decline has been followed by a rip your face off rally. My brain is that of an animal that has seen the same behavior over and over again." Although, I thought it was time to bet against stocks, I was afraid. 

Our brain is great in a environment with fixed rules. Never leave your wingman. Don't hit the car in front of you, etc. However, investing is not a fixed game. Real estate was a "sure thing" for decades up until the housing crisis. Bitcoin was a buy until it hit $20,000. 

The Bear has been asleep since 2009. 

Every market undergoes regime changes. People will always be most optimistic at the peak, and most pessimistic at the bottom. Equities in 2018, however, are particularly dangerous because the bullish regime that began in 2009 lasted so long, and was so powerful. Our brains (or at least part of them) have become convinced that buying stocks, especially on dips, is profitable. 

In preparing for a bear market, I wrote some months ago (click here), "Asset markets tend to move in ways that hurt the most people. The market sets people up for failure by behaving consistently in one way for long periods of time, and then changing character dramatically and rapidly.

Don't buy the Dip

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