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Buying on Dips and the Importance of Research

Most investors have had the unwelcome experience of watching a recent buy drop sharply. Its precipitous decline is matched only by the sinking feeling in your stomach as you watch a hard-earned chunk of change evaporate in the heat of the market.

Many of these same investors may also have compounded their woe by selling the offending stock, only to watch it bounce back up days later. How can you avoid this trap? The answer lies in one word: research.

Most investors realize the importance of research in identifying solid long-term buys. Unless you're a pure momentum investor or day trader, you need to know the "story" behind each stock you hold. Buying Yahoo! because it "looks good" or because "everyone else is in it" isn't good enough. Yes, it's possible to get lucky and make a profit in any stock, especially one with good momentum like Yahoo! But what would you do if Yahoo! dropped 30% or more in a single da. Would you average down? Cut your losses? Have you missed the boat, or is the best yet to come?

In these dark times of the soul, the investor's only ally is his research. For example, say you bought Quiksilver (NYSE: ZQK), a producer of apparel and equipment for the surf-snow-skate set, in November of 1997. A day later, it drops 30% to 11.5. What would you have done?

Well, the correct answer was "Buy!" Since that fateful day, Quiksilver has opened new factories, trounced earnings estimates, and split its stock. Investors could have known the future for Quiksilver looked bright if they had done their research. First, although the stock fell on news of a hit to earnings, a moment's pause would have yielded the realization that the hit was due to expenses in opening new factoriesto produce more of its clothing, which remained in high demand among the youth market it targets. Then, you might have reflected on the fact that the teen demographic in America is expected to increase through the year 2010 -- Quiksilver's potential market in this country is growing. Finally, you could have viewed its then-recent acquisition of well-established snowboard maker Mervin Manufacturing as an ideal move to extend its product line in a sensible, integrated fashion.

If you did all of the above and bought the dip, your reward was a double and then some. Likewise if you added even more when Quiksilver plummeted along with the market in last fall's brief bear scare. It bounced back once again, and even more quikly -- oops, quickly. On the other hand, imagine if you knew nothing about Quiksilver besides its ticker symbol. It was a pure momentum play for you. You began to panic. Maybe you read a few hysterical posts on messageboards from shortsellers with names like "BIG_BAD_BEAR" and "GoingDown", proclaiming that the end was nigh. (There are very few "nevers" in the investing world, but one of them is "Never sell based on hysterical posts from short-sellers." That goes double if the post is in all caps or exhibits incorrect grammar and spelling.) If you were one of the "cut-my-losses" crowd, you sold at a 30% loss and missed out on one of the hottest-performing stocks of 1998 without a ".com" after its name. Price volatility, in and of itself, is not a reason to sell. But without good research to turn to, it can sure seem like one.