Buy the dips. That’s a popular investment strategy. It is a popular strategy because it works. But, like almost every investment strategy, it only works sometimes. Buying the dips is only an effective strategy when the dip is actually just a dip within an up trend and not the beginning of a new bear market.
So, like with all investment strategies, it can be useful to define rules so that we know when to buy and when to avoid buying. For this strategy, we will need to identify rules that define the idea of a dip and an up trend.
Let’s start with the rules for an up trend. There are multiple ways to define the direction of the trend but one of the simplest ways is to compare the closing to a moving average (MA). If the close is above the MA, the trend is up. If the close is below the MA, the trend is down. This is just one tool that can be used to define the direction of the trend.
Many analysts have settled on fairly standard MA lengths for defining the trend. When looking at a long term trend, they use the 200 day MA. A short term trend can be defined with the 20 day MA. The 50 day MA can be used to define the direction of the intermediate term trend.
To buy dips, we would like to find stocks in short term pull backs within long term up trends. This means we can require the close to be below the 20 day MA to define a pull back and above the 200 day MA to define an up trend. To be safe, we will also require the stock to be above its 50 day MA.
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That is all we need to find dips. But, that would be a long and unmanageable list of stocks. To refine the list, we can add a price filter. We will limit our search to stocks that are trading under $5. This kind of cheap stock can be capable of making an explosive price move.
As an added filter for quality, we will require the company to be profitable. This means the price to earnings (P/E) ratio will be greater than zero. This step is not needed but eliminates some lower quality stocks that have no earnings and reduces the risk of the strategy.
We can set this screen up using the free stock screener at FinViz.com. The exact filters selected are shown below.
Stocks that passed our screen on FinViz are:
- AmeriServ Financial, Inc. (Nasdaq: ASRV) is a bank holding company that provides various consumer, mortgage, and commercial financial products. It offers retail banking services, such as demand, savings, and time deposits; checking and money market accounts; secured and unsecured consumer loans, and mortgage loans; safe deposit boxes, holiday club accounts, money orders, and traveler’s checks. The company also provides lending, depository, and related financial services. In addition, the company offers personal trust products and services.
- China New Borun Corporation (NYSE: BORN) produces and distributes corn-based edible alcohol in the People’s Republic of China. The company currently owns and operates two facilities, which supply corn for its daily operations. The facility in Shouguang, occupies a site area of 183,565.81 square meters, has 481 full-time employees and an annual production capacity of 160,000 tons of corn-based edible alcohol. The facility in Daqing, occupies a site area of 219,156 square meters, has 563 full-time employees and is licensed to produce 330,000 tons of corn-based edible alcohol.
- Emerson Radio Corp. (NYSE: MSN) designs, sources, imports, markets, and sells various houseware and consumer electronic products under the Emerson brand in the United States and internationally. The company provides houseware products, such as microwave ovens and compact refrigerators; audio products, including clock radios; and other products comprising televisions, mobile and landline telephones and accessories, tablet computers and accessories, cameras and video cameras and accessories, and miscellaneous electronic and novelty products. The company also licenses its trademarks to other companies worldwide.
- Ossen Innovation Co., Ltd. (Nasdaq: OSN) designs, engineers, manufactures and markets customized prestressed concrete (“PC”) steel materials used in the construction of bridges, highways, and other infrastructure projects in China, Europe, Latin America, Asia Pacific and the United States.
- SunLink Health Systems, Inc. (NYSE: SSY) provides healthcare related services in the United States. The company operates through two segments, Healthcare Facilities and Specialty Pharmacy. The Healthcare Facilities segment owns and operates an 84 bed community hospital, and a 66 bed nursing home in Mississippi; and a 100 bed nursing home in Georgia. This segment also leases the emergency department and auxiliary space of a closed hospital facility in Georgia to a non-affiliated healthcare operator; owns and leases medical office buildings; and owns and rents a closed hospital building for medical office. The Specialty Pharmacy segment offers specialty and institutional pharmacy services; and durable medical equipment and retail pharmacy products and services.
The chart of SSY can be useful to look at.
SSY has been in an up trend for about a year. This stock has now been forming a base since the beginning of 2017. Risk can be managed for this trade with a stop below the 50 day moving average or even the 200 day moving average.
- Tantech Holdings Ltd (Nasdaq: TANH) specializes in the R&D, manufacturing and sales of bamboo charcoal products for use as EDLC carbon materials, air purification products and charcoal briquettes. In addition, it provides bamboo vinegar, a liquid byproduct that is used in disinfectants, detergents, lotions, specialized soaps, toilet cleaners, and fertilizers, as well as in various agricultural applications; and bamboo carbon for use in EDLCs.
It is important to remember that the list of stocks you get when you run the screen may vary from our list. That is because price changes throughout the trading day as do the values of moving averages. Fundamental data could also be updated between the time we ran our screen and when you ran the same screen.
More important than the specific stocks is the process we followed to find the stocks. To find these stocks, we developed quantitative rules based on a logical premise. We wanted to buy stocks in long term up trends that are pulling back in the short term.
This screen can be run at any time. That identifies buys and then a trader needs to add rules for selling. For example, a break below the 200 day moving average could be a sell rule. More risk averse traders could sell on a break below the 50 day moving average.
When selling, it will be important to have a process in place to reinvest the cash. For example, a trader could rerun this screen and find new buy candidates. This may lead to more buy candidates than the trader can use.
In that case, a ranking system would be useful. FinViz.com allows traders to sort on any criteria that is shown. Sorting by the price to earnings (P/E) or price to sales (P/S) ratio could be used to find value. Technical indicators available at that site could also be used to sort the buy candidates.
With rules for selling, this screen could form the basis of a complete investment methodology. At that point, all that would be required for trading is discipline to follow the rules, always selling when the signal is given and always buying new positions when stocks are sold.