In the stock market, share prices regularly fluctuate. This doesn’t affect the amount of shares you own but the value of the shares. Usually, when these fluctuations happen, share prices may drastically drop depending on the reason, resulting in an opportunity to “buy the dip”.
This enables investors to reduce the purchase average. For example:
Instead of having two different holdings, batch one and batch two are combined and you are given a purchase average for your holding in the specific company.
The formula used (excluding costs)
(200 x 1) + (500 x 0.50) = 450
The total value of the holding (450), divided by the total number of shares (700) = $0.64: the average share price
The more shares you buy relative to the initial holding, the more the purchase average moves closer to the trading price, or the price for which you purchased the new shares.
Is a dip in a share price a bad thing?
The reasons for the share price dropping may differ from time to time. This doesn’t mean that a drop in share prices makes for a “bad investment”.
Sometimes these drops, or dips, can be because a company is not performing well. Other reasons may include:
Share dilution. Dilution of shares occurs when a company issues additional shares, resulting in a reduction in the value of existing shares. This usually occurs when a company is raising additional capital.
Sell-off. In terms of supply and demand, when the supply exceeds the demand of a specific share, this may result in a dip. The size of the dips may differ depending on the volume of shares sold during the period.
Importantly, buying the dip is focused on capitalizing on the short-term fall of a share price for long-term gains while considering the fundamentals and directions of a company.