In the wake of the crypto market selloff triggered by the collapse of the cryptocurrency exchange FTX (FTT -2.54%), it may be time to rethink some of the most popular crypto trading strategies. The one that immediately comes to mind is buying the dip, which has become the go-to move for many crypto investors. It is simply a matter of buying a crypto when its price has fallen and then profiting from it once the price returns to its previous level.
This strategy works best in a market that is trending up over time. But what about a falling market? As some crypto traders like to point out, what do you do when the downside continues to drop? With that in mind, here are some things to remember if you’re considering buying the dip.
What is a dive?
In 2022, the term “buy the dip” has become overused. People use it casually to describe buying a crypto every time it drops in value. But this makes it difficult to distinguish between different types of price declines and encourages market timing. For example, earlier this year people were talking about buying the dip with moon earth (LUNA 1.16%), which ended up collapsing and wiping out around $40 billion in market value. Undoubtedly, we will hear soon how we should buy the drop on FTX. But look carefully at the FTX chart: it’s not a dip, it’s an Acapulco cliff dive.
In stock markets, investors have very specific guidelines regarding price declines. For example, a market correction is generally defined as any price drop between 10% and 20%. Since the crypto market is much more volatile than the stock market, crypto investors should probably expand this range to reflect the larger price spikes that digital currencies are experiencing. From this perspective, a 20% drop in crypto markets is probably the most analogous to a correction in the equity market.
Is this crypto on sale for a limited time?
One way to think about buying a crypto on the dip is to ask a single question: is this crypto on sale for a limited period of time? Once you have determined that the crypto is on sale, you need to figure out why. This will help you determine if it is worth buying. At best, you can take advantage of short-term market inefficiencies.
For example, take Bitcoin (BTC -0.41%). Just a week ago, it was trading near $21,000 and has been trading steadily around $20,000 for months. Then when the news from FTX came, Bitcoin immediately traded at the $16,000 level. For much of the past week, it’s down almost 20%. Most people would say it’s on sale right now. The sell-off is unlikely to last, however, as Bitcoin fell due to panic selling in the market. So that would be an example of buying the dip.
More importantly, investors need to determine if this is truly a downside and not a long-term downside. Otherwise, you are going to be stuck with a lot of very ugly cryptos. Yes, you can get FTX at a 90% discount these days, but is it really a drop? The chances of him making a full comeback are slim to none. So you are basically speculating that FTX will bounce higher and you can time the market. But buying a so-called dead cat bounce is not a long-term investment strategy.
Alternatives to buying the dip
Keep in mind that there are many alternative crypto investment strategies. You don’t need to buy the dip to be successful. For example, you could just as easily adopt a dollar cost averaging strategy, where you buy the same amount of crypto at regular intervals. You will buy more when it drops, so you will naturally buy the dips. And you won’t have to worry about market timing. You will buy both downhill and uphill.
This does not mean that it is not worth buying cryptos on the downside. Certainly, there is evidence to suggest that this strategy has worked with Bitcoin over the past decade. But at some point, when you buy a crypto that has been discounted by 50% or more, and the crypto has been trading at that bargain level for some time, it is no longer accurate to say that you are buying the soak. You speculate hoping that the price of your asset will eventually recover. There are bargains to be found, but beware emptor!