Effectiveness of Buying the Dip

Is buy-the-dip (BTD) a reliably attractive stock market timing approach? In their April 2021 paper entitled “Buy the Dip”, Thomas Shohfi and Majeed Simaan devise and test various BTD strategies as applied to SPDR S&P 500 ETF Trust (SPY), as follows:

1. BTD with Lump Sum – 54 variations in which the investor progressively allocates a fixed percentage of an initial lump sum to SPY whenever the last real monthly return on SPY is below a specified threshold. Variations derive from different fixed allocation percentages and different return thresholds.
2. BTD with Monthly Inflows – five variations in which the investor receives cash flows at the beginning of each month and moves one monthly increment from cash to SPY whenever its prior-day return is below a specified threshold. Variations derive from different return thresholds.
3. BTD with MaxDD – nine variations in which the investor receives cash flows at the beginning of each month and initiates the strategy with 12 months of savings, allocating all cash savings to SPY whenever SPY drops below a maximum drawdown (MaxDD) threshold over a past rolling window. Variations derive from different MaxDD thresholds and different rolling window lengths.

They consider four strategy implementation dates, two associated beginnings of bull markets (January 1994 and January 2010) and two associated with beginnings of bear markets (January 2000 and January 2008). They use real (inflation-adjusted) returns on SPY and also deflate value of cash holdings accordingly. They focus on two strategy performance criteria: (1) terminal wealth at the end of 2020; and, (2) Sortino ratio. Respective benchmarks are passive strategies that allocate all cash to SPY as soon as the cash is available. They assume zero trading frictions and zero return on cash. Using daily dividend-adjusted SPY returns and monthly U.S. Consumer Price Index levels for inflation adjustments during January 1994 through December 2020, they find that: (more…)