Should You Buy Stocks When They’re Down?

When the stock market is down, some investors may shy away from making investments. And while you don’t necessarily want to buy stocks just because they are down, it could potentially be an opportunity for you to make investments at a discount. 

Sometimes, buying stocks when the market is down can be a good idea. However, the decision should be made based on rationale and not purely on the fact that the price is low. Read on to learn more about when and why you should invest in stocks when they’re down. 

Should you buy Stocks When They’re Down?

The big question is, should an investor buy stocks when they’re down? Well, the answer is it depends on the scenario. This article covers a few scenarios in which it could be smart for an investor to take advantage of decreased stock prices. 

Market Correction 

A market correction is defined as when a security loses value by 10% to 20%. Corrections can last anywhere from a couple days, months or longer. Typically, market corrections are seen as an opportunity to buy as the correction adjusts the inflated stock price. 

It is important to remember though that how long a correction lasts can be uncertain, so timing your investment will be crucial to this strategy. Additionally, you will want to understand what is causing the correction. Factors range from long-term unemployment, higher loan defaults, a poor earnings report and bad press among others. If the factors attributing to a market correction impact the overall broader stock market, it can signal to investors that a longer-term correction is occurring. If the factors are directly related to the underlying asset, the correction period may be shorter. 

Buy the Dip

A market dip is identified as when a security’s value drops by 30% or more after a sustained uptrend in the cycle. You have likely heard advice to buy the dip, meaning to buy after the price of a stock has dropped by 30% or more. Investors focused on the long term can benefit from buying the dip. This strategy is based on the assumption that the price decline is temporary and short term. 

After a pullback in the market, prices can soar to a new high, making this strategy popular among investors. However buying the dip is all about timing the market, which can be hard to do. This strategy comes with the risk of loss; however, if you execute it properly, you can realize great returns. 

Undervalued Stocks

Another scenario in which investors might buy is when they believe that the market has undervalued the price of a stock. Markets can misprice stocks, and taking advantage of a mispricing is a strategy investors have long used. Stocks can be mispriced for several reasons including sector-specific factors, an overall market slowdown, sell-offs or an up-tick in emotional trading. 

One of the most popular ways to identify undervalued or overvalued stocks is the discounted cash flow (DCF) method of valuation. This methodology takes into account a company’s prospects for growth and profit by forecasting future cash flows and then discounting them back to the present using a discount factor that reflects the level of risk you are taking on. This valuation method will give you an implied enterprise value, which you then divide by the total number of shares outstanding, to give you the correct implied price per share. If your valuation outputs a price per share that is higher than the actual price per share in the market, it indicates that the stock may be undervalued and could eventually increase to at least your implied price per share. 

Buying After a Sell-off

A sell-off occurs when a large volume of shares are sold in a short period of time. When this happens, share prices will initially fall because of the large volume of shares added back into circulation. Furthermore, sell-offs can trigger an emotional response from other investors who follow and also sell off their shares. This in turn can cause a decrease in the stock’s price.

While a sell-off may be disheartening to some, others see it as a buying opportunity. Because the emotional response of a sell-off can trigger selling, a stock price may deflate further than it should have. This creates entry points for other investors to buy in and take advantage of the undervalued shares. 

What is a Bear Market?

A bear market is described as a prolonged period of price declines, typically 20% or more. Bear markets tend to occur amid economic downturns and investors will be more pessimistic with negative sentiments towards the overall market. On average, in the past bear markets have lasted about 14 to 16 months at a time. 

What are the Signs of a Bear Market?

Bear markets are usually a result of weakening economies. Several factors go into a bear market, like poor economic growth, asset bubbles popping, war and geopolitical factors. Some indicators of a bear market nearing include increased borrowing cost, declining stock prices and overall negative investor sentiment. 

Safe Investments for a Bear Market

Some of the safest investments you can make during a bear market are in defensive sectors of the stock market. These sectors include consumer staples, commodities, utilities and the healthcare sector. Investing in index funds and ETFs within these sectors can also be a safe investment. 

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