Finance maven, Aswath Damodaran, has highlighted against a simplistic interpretation of “buying the dip” in his latest blog post, underscoring how this contrarian investing strategy could not always benefit the investors without a thoughtful approach.
What Happened: The professor of finance at the Stern School of Business in New York University, Damodaran, has dissected the various paths to taking on contrarian bets while cautioning investors against simply buying every downward price movement without understanding the narrative.
Buying the dip could be “akin to catching a falling knife,” explains Damodaran, as initial market drop can be a prelude to a much larger sell-off off with there may be no near-term bounce back.
Instead of a one-size-fits-all approach, Damodaran outlines several distinct paths for contrarian investors:
- The Value Contrarian: Focuses on fundamentally undervalued companies unfairly punished by the market, patiently buying dips in sound businesses for long-term value recognition.
- The Sentiment Contrarian: Bets against widespread market pessimism, buying dips based on the belief that overreactions create opportunities, provided fundamentals remain intact.
- The Catalyst-Driven Contrarian: Buys dips in companies facing temporary issues, anticipating a specific event will resolve the problems and trigger a market re-evaluation.
See Also: Xi Jinping’s China Pledges Retaliation Against Countries Isolating Beijing By Giving Into Trump Administration’s ‘Unilateral Bullying‘
Why It Matters: Damodaran thinks that buying when the markets are falling takes “a mindset, a time horizon, and a stronger stomach” than most people have.
“Buying when the rest of the market is selling takes a mindset, a time horizon, and a stronger stomach than most of us do not have,” he adds.
Furthermore, he stressed the importance of due diligence and conviction. Contrarian investing requires rigorous research to understand the underlying business, its financials, and the reasons for the market’s negative perception.
Without this conviction, investors are likely to panic and sell at the first sign of further decline, negating the potential benefits of their contrarian bet.
Lastly, leveraging a long-term view and risk tolerance, Damodaran said that he has initiated limit buy orders for BYD, MercadoLibre Inc. (NASDAQ:MELI), and Palantir Technologies Inc. (NASDAQ:PLTR), which he aims to add to his portfolio. His BYD order was triggered on April 7th at under $80, while orders for Palantir and Mercado Libre remain active.
Price Action: By Thursday’s market close, the S&P 500 had fallen 14.1% from its record high of 6,147.43. The Dow Jones was down 13.15% from its 52-week peak, and the Nasdaq 100 had dropped 17.84% from its high.
The SPDR S&P 500 ETF Trust (NYSE:SPY) and Invesco QQQ Trust ETF (NASDAQ:QQQ), which track the S&P 500 index and Nasdaq 100 index, respectively, ended on a mixed note on Thursday. The SPY was up 0.14% to $526.41, while the QQQ declined 0.018% to $444.10, according to Benzinga Pro data.
On Monday, the futures of Dow Jones, S&P 500, and the Nasdaq 100 indices were down 0.71%, 0.68%, and 0.70%, respectively, at the time of writing.
Read Next:
Disclaimer: This content was partially produced with the help of AI tools and was reviewed and published by Benzinga editors.
Photo courtesy: Shutterstock