Should you buy the dip the day after stocks drop? Maybe
When the going gets tough the tough get going.
Yesterday’s market mayhem, in which the Nikkei 225 recorded its worst one-day drop since 1987, US stocks fell 3%, and the Magnificent 7 shed some $650 billion of market cap, saw Wall Street’s “fear gauge” hit levels not seen since the pandemic.
It was, as Luke Kawa put it, what panic looks like.
Whenever stocks make the headlines, there’s always an army of people — from professional fund managers to retail traders — ready to tell you exactly what to do next: buy the dip.
But, what does the data say about that strategy? A simple inspection of every single day the S&P 500 has fallen more than 2% since 1970 reveals that, a slim majority (54.5%) of the time, stocks do indeed rise the day after a 2%+ fall. On average, per our calculations, the S&P 500 Index rose 0.14% the day after a 2%+ drop.
The Nikkei 225 obviously didn’t get the memo: the Japanese index which cratered yesterday has rebounded sharply, up 10% this morning.
What about a longer time horizon: A tome of academic research has found evidence of both mean reversion (stocks reversing course) and momentum (stocks continuing to trend in the same direction) in equity markets. How can they both be true? The difference lies usually in how long a time period you’re measuring.
In the long run, stocks tend go up.
