How to Buy the Dip in Futures

 

This article on How to Buy the Dip in Futures is the opinion of Optimus Futures.

How to Buy the Dip in Futures

You’ve likely seen it on social media or heard it among your Millennial and Gen Z buddies: BTFD (aka, Buy The F*!#ing Dip!). It’s a meme that comes up on social trading feeds every time an asset sinks: BTFD!

Of course, the saying has been around for a while, and for the decades that it’s been around, it’s never ceased to befuddle investors and traders who can’t read anything more into it other than a simple command to buy.

So, we’re going to break “BTFD” down for you—namely, what it means to buy the dip, how to measure it, and how to determine when or where to buy. Most importantly, we can help you figure out when to avoid buying the dip.

Note that we’re going to be addressing the futures market specifically and that the lessons below are written for day traders and swing traders.

If you find yourself in that crowd, let’s proceed. Here’s what we’ll cover:

  • What in the heck is a “dip”?
  • How to distinguish a significant decline from a reactionary dip.
  • The pros and cons of “buying the dip.”
  • Trading tools and indicators to help you measure and trade dips.

What’s a Dip?

To “buy the dip” means to buy an asset after it has dropped in price. As you might have experienced yourself, “buy the dip” advice is vague and often problematic.

So, a “dip” is a decline in price. That part is easy to get. But is it a short-term or longer-term pullback? Can it be a weeks-long downswing? Might it be a downtrend? What if it’s referring to an entire bear market?

The problem with this term is that it can be ALL OF THE ABOVE, depending on the time frame you’re trading. A dip can be a minutes-long micro downtrend as well as a months-long bear trend. More on this later.

When you hear the word “dip,” the assumption is that the newly “discounted” prices makes the asset something of a bargain.

If it’s a bargain, then it will eventually bounce back up in value. Your own trading experience might tell you that this is not the case. A futures instrument that dips in value might keep declining.

In this case, you’re catching a proverbial knife when you should be steering clear of it.

So, this begs a couple of important questions:

  • How might you know when a market’s decline might be favorable to buy?
  • How might you determine a strategically favorable buy point?
As a trader, your best efforts might be to rely on technical indicators and methods to determine a strategic buy point, stop loss, and take-profit level.

Disclaimer: The placement of contingent orders such as a “stop-loss” or “stop-limit” order, will not necessarily limit your losses to the intended amounts, since market conditions may make it impossible to execute such orders

It helps to understand things like buying and selling pressure, and all of the indicators that can detect such conditions.

But be sure to see the big fundamental and economic picture so that you don’t get stuck trading a technically-sound setup against an economically-driven move that contradicts your directional bias.

When trading a dip, the time frame is critical

There are many smaller price swings within a single price swing. There are many trends within a trend. In between these multiple trends are various trend exhaustion points.

Not all of them are favorable and many do not indicate a sustained movement in the opposite direction. This is where following larger time frames is critical.

Here’s what the Nasdaq 100 futures looked like on January 7, 2022, using the 5-minute chart. Notice all of the dips indicated by the arrows.

Nasdaq 100 Futures (NQ) – 5 minute chart – February 7, 2022 (Source: Tradingview)

Nasdaq 100 Futures NQ - 5 minute chart - February 7, 2022

There may be plenty of “buy the dip” opportunities here but trying to catch all of them might result in a blown-up trading account (hint: it’s much harder than it looks).

So, instead, you might choose to go for a single trade on a trending day, as was the case on January 28, 2021.

Nasdaq 100 Futures (NQ) – 1-hour chart – January 28, 2022 (Source: Tradingview)

Buy The Dip - Nasdaq 100 Futures NQ - 1-hour chart - January 28, 2022

Or, if you’re looking for a much larger price move to swing trade, you might zoom out to see the larger trend. But there’s a problem.

Nasdaq 100 Futures (NQ) – 1-Day chart – November 10, 2021 – February 7, 2022 (Source: Tradingview)

Nasdaq 100 Futures NQ - 1-Day chart - November 10, 2021 - February 7, 2022

THE IMPORTANT LESSON HERE IS TO RESPECT THE TIME FRAME YOU’RE TRADING. DON’T CONFUSE MICRO-TRENDS WITH LONG-TERM TRENDS.

A dip for a day trader is not the same as that for a swing trader or a long-term position trader. Pullbacks are more frequent in short-term charts and less frequent in longer-term charts (as we showed you in the examples above).

Now that we’ve cleared an issue that tends to confuse many traders, especially new ones, let’s get to the hows of analyzing and trading pullbacks. Let’s explore how to BTFD.

Is it a Dip, or the Start of a Deeper Dive?

As a technical day traders, we understand the bias that “price action reflects all of the fundamental information that has materialized.” And to that, we’ll come back with a resounding NO, IT DOESN’T.

Noise isn’t a reflection of significant economic movements.

Unless you pay attention to the larger fundamentals of your futures market, you may not know exactly what’s going on in your market.

Even worse, you won’t be able to distinguish a mere blip in the market from the beginnings of a significant market decline.

Countless day traders have been T-boned by an economic report, such as Jobless Claims, despite its reporting period taking place at the same time and on the same day each week.

If you’re not going to follow the markets from a fundamental perspective, at least check your economic calendar to make sure you’re not taken by surprise by something you could have seen coming days or weeks ahead.

This is why Optimus Futures offers clients Optimus News, designed not only to provide a comprehensive scan of the market environment but to help you tactically navigate the sometimes rough and volatile landscape of news-driven events.

BTFD Pros and Cons

Let’s talk about the advantages and risks. Here are the main ones:

  • Buying low and selling high: Buying the dip positions you for greater upside potential if your asset reverses course. If the essence of trading is to buy low and sell high, then buying the dip ensures that you are at least buying at a time of declining value. Caveat: If you buy too early, you may be “catching a falling knife.” Furthermore, if you overestimate the upside value of your market while underestimating the downside of its decline, you may be stuck with an asset that’s underwater in value for an extended period of time.
  • Building your long position: A falling asset allows you to scale into your long positions. Some call this “averaging down.” There’s nothing wrong with averaging down if you know, technically and fundamentally, what you’re doing. Most importantly, you have to be skilled at managing your risks so that they don’t turn into major losses. And this leads to our big caveat. Caveat: If you scale in the wrong way, you’re compounding your losses on the way down.
When it comes to analyzing and taking action on dips, this is where fundamental forecasts differ from purely technical trend-following systems even among “day traders.” As we said at the beginning, it’s important to follow both approaches when assessing a plunging market. Here are a few approaches to consider.

Strategy #1 – Plot Critical Support and Resistance Levels

When you’re looking to go long in a market that’s plunging, you’re probably wondering a) how far down price might go before it bounces back, and b) where prices are in relation to that potential bounce-back point.

For example, take the Bitcoin futures on January 24.

Bitcoin Futures (BTC) – 5-minute chart – January 20 – 25, 2022 (Source: Tradingview)

Buy the Dip - CME Bitcoin Futures

If you were looking at only the 5-minute chart, you might have wondered why buyers jumped in specifically at that level or price range. Chances are that traders were eying the historical support range between 28,000 and 30,000.

Bitcoin Futures (BTC) – Weekly chart – January 4 – February 7, 2022 (Source: Tradingview)

Bitcoin Futures BTC - Weekly chart - January 4 - February 7, 2022

So, the lesson here is to plot out historical support and resistance, preferably on a larger chart. Zooming out can help you identify big turning points and critical levels in the market.

Most importantly, they can help prevent you from getting “lost” amid volatile fluctuations.

Strategy #2 – Fibonacci Retracements As Key Entry Points

You’re eyeing a particular futures contract that’s recently begun to pull back. You want to open a position during the retracement phase hoping it would eventually reverse and continue moving upward.

Here’s the big question: at what point might you actually pull the trigger?

Buy the Dip - Fibonacci Retracements As Key Entry Points

Here’s where Fibonacci retracement levels come in really handy. The depth of the retracement is key to deciding when to enter a falling market. In a nutshell, here’s a simple way to read Fib retracements:

  • At a 2% decline, early buyers may begin entering the market. If enough buyers enter, overpowering the sellers, some short sellers may begin closing their position, barely scratching a profit.
  • If the price declines by 50%, both bulls and bears are seeing “green.” Both will likely wait to see whether more buying overpowers selling or vice versa. Eventually, one side will overtake the other.
  • An 8% retracement is critical. This is the level that many buyers might even consider ideal, as it presents the most favorable return without indicating a potential bearish reversal. However, you have to be careful, as any close below 61.8% may prompt bulls to sell their long positions, as a close below that level indicates a weakening or failed upswing.
Here’s a real-world example:

Crude Oil Futures (CL) Daily Charts – Nov 17, 2021 – Feb 8, 2022 (Source: Tradingview)

Crude Oil Futures CL Daily Charts - Nov 17, 2021 - Feb 8, 2022

Another example:

Copper Futures (HG) Daily Charts – Jan 7 – May 19, 2021 (Source: Tradingview)

Copper Futures HG Daily Charts - Jan 7 - May 19, 2021

When a market dips, Fibonacci retracement levels can be useful in forecasting when a market may bounce. The duration of the upward bounce depends, of course, on fundamentals or market sentiment.

But since traders are eyeing these levels, Fib retracements can sometimes materialize as a self-fulfilling prophecy. Hopefully, it’ll be enough to yield a reasonable profit.

Strategy #3 – Mind the 50 – 200 Day Moving Averages

If you’re a financial news junkie, like traders often are, then you’re more than familiar with the 50 and 200-day moving average (50 and 200 MA).

The 50 day MA is often cited as intermediate-term support while the 200-day represents longer-term support.

Both represent the strength of the intermediate to long-term trend. They’re also lagging indicators, meaning it takes several days for a new trend (or non-trending market) to be reflected by either of the averages.

Let’s focus on the “support” thesis. When an asset takes a dive and reaches either of the moving averages, buyers tend to jump in. Take a look at the Dow futures below to see what we mean.

Dow Jones Futures (YM) Daily Charts – August 21, 2020 – June 7, 2021 (Source: Tradingview)

Dow Jones Futures YM Daily Charts - August 21, 2020 - June 7, 2021

Why are these both “buy the dip” areas? Traders interpret them as strong “value” areas for both intermediate- and long-term trends.

Furthermore, if the 50 MA is trending strongly above the 200 MA, that’s a sign for a reasonably robust uptrend. In this scenario, the 50 or the 200 make for good BTFD areas, as long as the uptrend is still intact.

Now, if the 50 crosses below the 200, also known as the “death cross,” then it often spells trouble for a market.

By that time, the price of a futures contract is probably well below both MAs. And this dip you do NOT want to buy (unless you know of a fundamental change that other traders don’t see).

The Bottom Line

To buy the dip with greater accuracy, we suggest using (in any of the three strategies above) a more pinpointed approach for market entry such as the 1-2-3 pattern.

This price action pattern is a fractal-like principle that occurs throughout all time frames. If anything, it can protect you from falling knives when seeking a bargain buy.

Buying the dip takes a lot of skill and know-how. You have to be able to see the big picture.

And that’s why we recommend developing a 360-degree sense of what’s going on in the market. That means upgrading your technical, fundamental, and economic chops. Happy trading!

Disclaimer: There is a substantial risk of loss in futures trading. Past performance is not indicative of future results.

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