Is Retail Investor Dip Buying a Warning Sign?

MarketWatch columnist Mark Hulbert pointed out that despite the Dow's nearly 900-point plunge last Friday, retail investors eagerly bought the dip, which is a warning sign. This investor behavior is actually bearish for the market because their willingness to buy the dip is a contrarian indicator: When investors view a dip as a buying opportunity, the stock market is often near its peak; while at the bottom, the situation is exactly the opposite - investors do not believe that any rebound will last and will regard every market rise as an opportunity to sell further. Data collected by Yale University finance professor Robert Shiller confirms this view. Since 2001, he has been calculating the "Buy-on-Dip Confidence Index", which is used to measure the proportion of retail investors "who believe that the stock market will rebound the day after a significant decline". As can be seen from the attached chart, the performance of the S&P 500 index after this index is at a high level is, on average, much worse than the performance after the index is at a low level.

Data Lag and Market Risks

It should be noted that Shiller's "Buy-on-Dip Confidence Index" update has a several-month lag, so it is not yet clear how retail investor behavior last week will affect the October index reading. But there is no doubt that their enthusiasm to "rush to buy the dip" last Friday was close to a five-year peak, which is not a good sign at all. It is important for investors to understand this data lag and consider other information sources to make informed decisions.

Further Evidence from Robinhood

A related study by online trading platform Robinhood Markets provides further evidence that "last Friday's buying-the-dip rush should be treated with caution" - the platform has attracted a large number of retail investors. The authors of this study, titled "Attention-Driven Trading and Returns: Evidence from Robinhood Users," found that, on average, stocks heavily bought by Robinhood investors on a given day underperform the overall market by 5% in the following month.

Caution Advised

Although historical precedents do not guarantee that recent investor behavior will necessarily lead to market weakness. Similar situations have occurred in the past, especially in the frenzied stages of a bull market, even when "buy the dip" sentiment is extreme, the market will continue to rise. But that doesn't mean risks haven't risen to dangerous levels. As Warren Buffett of Berkshire Hathaway warned: Be fearful when others are greedy. This timeless reminder highlights the importance of caution and thoughtful risk assessment in financial markets.