These two strategies define an entry point into an already established trend. How you implement either will also be influenced by:
- The time-frame you trade,
- Your exit management, and
- Your underlying fundamental opinion of what you are trading.
Buy the Dip
This approach defines your entry at a point after the price has retraced against the broader trend.
In a counter-trend movement, your analysis will define that the ‘pull-back’ or retracement is not gathering sufficient momentum or seller activity to result in a change in broader trend. Your opinion is that the broader trend will hold, and that the pull-back is an opportunity to enter a new Long position.
What I find more efficient is to use Price analysis techniques to identify a Bullish reversal point. I’m not in the game of “Trying to Catch a Falling Knife”; that is, buying into a price that is falling. I prefer to have evidence that market sentiment has changed before I’m willing to commit my money to the trade.
There are many different patterns you can learn, but the simplest method is to identify a Bullish Reversal point, or Key Reversal. This is defined by:
“Today’s high/low price being higher then yesterday’s high/low price. Where yesterday’s high/low was a continuation of downward high/lows.”
Other key analytics for a Buy the Dip scenario are:
- Market was overbought at peak of counter-trend movement
- Retracement is to a level of significance; such as a support level, moving average, or trendline
- There is sufficient upside potential to the previous high to warrant a profitable trade
- That the previous high is not a primary resistance level
Risks of the Buy the Dip approach, as they always are for any strategy, is that this retracement/pull-back results in a change in trend. Hence, your opinion that the broader trend has a high probability of continuing is the underlying premise of the trade. You are merely looking for an opportunity for entry/re-entry.
And as with all trades, your exit strategy can be influential on success of the trade. You need to be able to ride through any consolidation in price or further short-term retracement to capitalize on the next upwards leg of the overall trend. Exit levels that are too tight could stop you out too early.
Buy High Sell Higher (Breakout)
For this strategy, the difference is that your entry into a position can be at any point, although it is more likely to be as you push into a new high price (say, beyond the last peak/trend high).
As with the Buy the Dip entry approach, your underlying fundamental view is that the Bullish trend will remain in place.
You do not necessarily need to identify a price pattern for entry into Buy High Sell Higher. Your entry will typically be at any point, as long as it has been a positive day. The only criteria you might consider, as mentioned before, is a breakout of a previous high or resistance level.
The biggest Risk you have with this approach is that it is a “False Breakout” – that is, the push higher stalls immediately after the break.
Price analysis techniques can help to alleviate a false breakout, such as:
- Strength of buyers as measured by candlestick size and volume
- The degree of ‘overbought’ at time of new high
- Momentum analysis of the broader trend – signals of slowing trend momentum suggesting less upside in trend.
Again, your exit strategy can have a significant impact on the success of your trade entry. With all established trends, the ideal exit level is the previous low point or support base. Your position management should take into consideration where this is in relation to your potential loss. Remember, a break below the previous low/support, is the first sign of a potential change in trend.
Both entry approaches are sound methods for beginners or experienced traders. Having a clear understanding of triggers you need to see to implement the strategy, and the Risks associated with how that entry will impact your trade management.
Management of your position will then be determined by the uncontrollable factor of market movement in the underlying. Your role is to set up a position that suits your trade management approach, selecting the trade based on a ‘higher probability’ of success.