Why you should NOT always buy the dip? Zerodha's Nithin Kamath explains

Online broking firm Zerodha's co-founder Nithin Kamath sounded an alarm on fall in prices of many retail favourite stocks, including Zomato, adding that buying the dip may not always be the best idea. This comes amid a plunge of over 11 per cent in shares of food delivery giant after the one-year mandatory lock-in period for promoters, shareholders, and others ended on Monday. The lock-in period refers to that period for which investments cannot be sold or redeemed.

Explaining the trend, Kamath pointed out that every time the prices of retail favorite stocks fall, the number of investors who buy the stock goes up dramatically. He added that the trend was seen with Yes Bank, Reliance ADAG stocks earlier and now, is seen with Zomato's scrip as it has crashed 61.33 per cent since their listing on July 23, 2021.

In a series of tweets, the Zerodha boss explained how in the business of investing, if a stock price is down and it seems like it is a cheap buy, odds are it will continue to become cheaper. "The optimal way to trade is to buy stocks that are doing well and sell them higher as they grow," he wrote.

He also advised the retail investors to avoid averaging down to reduce one's average buy price in the hopes of making a profit or breaking even IF the price goes up. "Yes, there are times when it works, but the issue with this strategy is that one bad trade is enough to wipe out all previous profits and more," he added.

Cautioning investors on buying the dip phenomenon in this volatile market, Kamath elaborated, "We all suffer from Disposition Bias—we feel like selling stocks that are going up and hanging on to stocks that are falling down. To do well when investing, you need to do the opposite—hold on to winners and sell the losers."

He also mentioned that the investors must mix technicals with fundamentals. Explaining further, he stated that a stock that seems cheap at Rs 100 for fundamental reasons will seem cheaper at Rs 50, tempting to average down, but technicals will show if there's a downtrend—a warning sign to maybe not buy, buy less, or exit.  

However, turning back on the traditional method of investing, Kamath reiterated that the most important aspect of investing is to diversify. "We live in a world with no status quo. Any company/sector can get disrupted & lose a lot of value. Avoid holding more than 10-20% of any single stock or sector, the lesser, the better. It's still high but better than 50%," he concluded.

Meanwhile, benchmark indices on Thursday rose on hopes of US Federal Reserve Bank may go slow on interest rate hikes after delivering an in line-75 basis points rate. During late trading hours, Sensex zoomed over 1,000 points, and the Nifty50 was quoting above 16,900. The BSE m-cap was trading Rs 2.8 lakh crore higher at Rs 262.53 lakh crore.