When the omicron variant started making headlines and stocks hit the headlines on November 26, some traders posted to Reddit’s WallStreetBets group said it was a Black Friday sale. Were Company Shares Really Discounted?
The redditors are not the only ones looking to buy the downside, as the investment strategy is known. Multiple surveys indicate that the covid-19 pandemic has attracted a new generation of traders (pdf). The ability to buy stocks when their price drops was the third most popular reason to open a new account in 2020, according to a survey by the Financial Industry Regulatory Authority (FINRA) and the National Opinion Research Center at the University of Chicago . (Saving for retirement and the ability to invest small amounts of money were the two main reasons.)
Getting more people to invest might be a good thing. Long-term equity holdings can be an important generator of wealth, and involving more of society in financial markets – responsibly – could help close the wealth gap, giving more people the possibility of saving for housing, retirement or paying for education. But as social media helps attract and educate a new wave of traders, a key question is whether they are receiving good advice or are about to be disappointed.
There are signs that retail investors were indeed feeling bullish on November 26, when the S&P 500 index of large US stocks fell 2.3%, the largest drop since January. The mentions of call options – representing a bet that an asset will rise in price – on WallStreetBets have far exceeded those of put options – which represent a bet that something will lose value – in the days that have passed. tracking, according to data compiled by Quiver Quantitative, an alternative data provider. While it is common for calls to overtake puts, quantitative data from Quiver shows that the ratio between calls and puts was trending upward towards calls.
Other research also suggests that individual investors went on a buying frenzy when stocks fell on November 30. by Bloomberg.
Is buying the dip a good idea?
Buying the dip is not as easy as it seems. If market prices take too long to fall, you could end up with inflation-eroded cash instead of taking advantage of a rising market and receiving dividends and coupons from stocks and bonds. It is not because an asset has fallen in price that it cannot fall further. An analysis from Northwestern Mutual, a financial services company, found that investing your money immediately (lump sum) typically pays more than robotic spreading it over time (cost average).
Other research signals buying the plunge may not be so bad. Thomas Shohfi of Rensselaer Polytechnic Institute and Majeed Simaan of Stevens Institute of Technology compared the lump sum investment and cost averaging. Then they analyzed whether buying the bearish through an S&P 500 index fund would have made more money in these scenarios. They found that historically buying on the down led to more wealth than a lump sum investment and less wealth than just a systematic investment every month. But they also found that buying on the downside could provide lower risk-adjusted returns.
âWhat this means is that the strategy gives me good returns with lower risk,â Simaan said in an email. “Intuitively, this equates to a policy that generates good returns while reducing the anxiety that your portfolio will drop sharply over time.”
While buying from the downside isn’t a sure thing, it might not be that big of a deal if it attracts more people to long-term investments in the US stock market, which has proven to be a critical way. to build wealth over time.