A wildly popular stock market strategy is hotter than ever – Business Insider

options traderScott Olson / Getty Images

  • A stock market investment strategy known as “buying the dip” has enjoyed an unprecedented period of popularity and success.
  • This shows that investors are no longer afraid of market weakness, but instead embrace it, says Bank of America Merrill Lynch.

Stock market pullbacks don’t worry investors anymore — they embolden them.

For much of the 8 1/2-year equity bull market, traders have deployed a strategy called “buying the dip,” which involves adding to bullish positions whenever stocks drop. Even the briefest market decline gives these traders a chance to buy more of a stock that they’re into at a lower price.

It’s a tactic that’s been crucial in keeping the stock market rally afloat, with the ever-present undercurrent of optimism providing a backstop of sorts for major indexes. And it’s been so effective that investors are now embracing brief rough patches, says Bank of America Merrill Lynch.

“Investors no longer fear shocks but love them,” a group of strategists led by Nitin Saksena wrote in a client note. “Since 2013, central banks have stepped in — or communicated that they may step in — to protect markets, leaving investors confident enough to buy the dip.”

Saksena’s point about the role of central banks is a crucial one. For years, the accommodative monetary policies of the Federal Reserve, European Central Bank and Bank of Japan have underpinned the US equity rally.

The dip-buying phenomenon can be at least partially seen through the propensity of investors to shift directions, often within the same day. Evidence of this is in the chart below, which shows intraday realized volatility recently hit a record high:

Screen Shot 2017 12 13 at 8.58.28 AMThe rise in intraday realized volatility is symptomatic of the growing popularity of dip-buying. Bank of America Merrill Lynch

Here are three recent high-profile examples of dip-buying in action:

  • In May, the S&P 500 fell 1.8% in a single day. It then recovered 85% of that loss over the following three days, the second-fastest retracement of a loss that big in the index’s history, according to BAML data.
  • In June 2016, the S&P 500 fell by 5.3% over two trading sessions following the UK’s vote to leave the European Union. The benchmark then recovered those losses in about a week.
  • In August 2015, when China unexpectedly devalued its currency, the S&P 500 underwent an 11% correction. Then traders bought the dip and restored the index to its pre-selloff levels within about two months.

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