In the wake of the broad crypto market sell-off triggered by the collapse of cryptocurrency exchange FTX (FTT), it could be time to rethink some of the most popular crypto trading strategies. The one that immediately comes to mind is to buy the dip, which has become the go-to move for many crypto investors. This simply refers to buying a crypto when it has declined in price, and then profiting once the price returns to its previous level.
This strategy works best in a market that is trending up over time. But what about a market that is trending down? As some crypto traders like to point out, what do you do when the dip keeps dipping? With that in mind, here are a few things to remember if you're thinking about buying the dip.
What is a dip?
In 2022, the term "buy the dip" has become overused. People casually use it to describe buying a crypto anytime it falls in value. But this makes it hard to distinguish between different types of price declines, and it encourages market timing. For example, earlier this year, people were talking about buying the dip with Terra Luna (LUNA -3.11%), which ended up collapsing and wiping out roughly $40 billion in market value. No doubt, we'll soon be hearing how we should be buying the dip on FTX. But take a close look at the chart for FTX: That's not a dip, that's an Acapulco cliff dive.
In the equity markets, investors have very specific guidelines for price declines. For example, a market correction is typically defined as any drop in price between 10% and 20%. Given that the crypto market is much more volatile than the equity market, crypto investors would probably need to expand that range to reflect the bigger price spikes that digital currencies experience. From this perspective, a 20% dip in the crypto markets is probably most analogous to a market correction in equities.
Is this crypto on sale for a limited time?
One way to think about buying a crypto on the dip is by asking a single question: Is this crypto on sale for a limited period of time? Once you have determined that the crypto is on sale, then you need to figure out why. This will help you determine whether it's worth buying. In a best-case scenario, you can profit from short-term market inefficiencies.
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For example, take Bitcoin (BTC -2.03%). Just a week ago, it was trading for close to $21,000 and had consistently been trading around $20,000 for months. Then, when news of FTX hit, Bitcoin immediately traded down to the $16,000 level. For much of the past week, it has been down almost 20%. Most people would say that it is on sale right now. The sale probably won't last, though, because Bitcoin fell due to panic selling in the market. So this would be an example of buying the dip.
Most importantly, investors have to determine whether it is really a dip, and not a long-term decline. Otherwise, you're going to be stuck holding a lot of very ugly cryptos. Yes, you can get FTX at a 90% discount these days, but is that really a dip? The chances of it making a full comeback are slim to none. So you're basically speculating that FTX is going to bounce higher and that you can time the market. But buying a so-called dead cat bounce is not a long-term investment strategy.
Alternatives to buying the dip
Keep in mind that there are plenty of alternative crypto investment strategies. You don't need to buy the dip to be successful. For example, you could just as easily adopt a dollar-cost-averaging strategy, in which you buy the same amount of a crypto at regular intervals. You will buy more when it is falling, so you will naturally be buying the dips. And you won't have to worry about timing the market. You will be buying on the way down as well as on the way up.
This is not to say that it is not worth buying cryptos on the dip. Certainly, there is proof to suggest that this strategy has worked with Bitcoin during the past decade. But at some point, when you are buying a crypto that has been marked down by 50% or more, and the crypto has been trading at this bargain-basement level for quite some time, it's no longer accurate to say that you are buying the dip. You are speculating, hoping that the price of your asset will eventually recover. There are bargains to be found, but caveat emptor!
