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Split and Dip Stock Market Strategy

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Purpose or Problem

The purpose is to determine if a specific strategy for buying or selling stock in the stock market might be profitable over a period of time.

Overview

What's the secret to making money in the stock market? It's simple: buy low, sell high. That's it! Everything else is just "noise." Buy a stock when its price is low and sell it at a later date when the price has appreciated. Of course, the hard part is picking a stock whose price will appreciate.

Most successful investors buy stock in a company they have thoroughly researched and they believe the company has great potential for increasing its earnings in the future. When a company has increasing earnings, the price of its stock usually increases. Buying stock in a good company and holding onto it for many years is a great way to build a nice nest egg.

But, some people try to get a much quicker return on their money. They attempt to buy and sell stocks in a very short period of time, perhaps over a period of several weeks or months. Some even buy and sell within the same day; they are known as day traders.

Short-term investing can be very risky, however, and, many times, an investor will lose money or miss out on really big gains because a stock was sold prematurely. Patience usually gives investors an edge.

Nevertheless, the fearless investor is lured to a quick profit by short-term trading, just as a gambler is drawn to the chance for a big win with the pull of a slot-machine handle.

Stock market trading, however, is not quite the same gamble as pulling the handle on a slot machine. Naturally, some luck is involved and some uncontrollable factors are at play. But the odds are more in your favor in the stock market, where you can do your homework researching a company and its products, and developing strategies based on the past performance of a stock.

Stock market gurus are everywhere, selling newsletters and services, each one making recommendations as to which stock to buy, based on their "unique" strategies. How accurate are the predictions by these gurus? Their theories must be tested over time with a large sample of stocks.

Let's propose a strategy of our own, and then, over a period of two months, test our theory with a large sample size. Our strategy will be a short-term play. We will attempt to buy low and sell high within a few weeks or months to make a small profit.

Our strategy is to buy a stock if it takes a slight "dip" within the first three weeks of doing a stock split, and then selling the stock several weeks after that as the stock begins to climb.

What is a stock split? A stock split is when a company divides its total number of shares of stock to make more shares available. For example, suppose a stock is selling for $100 a share and you own 20 shares. If the company does a 2-for-1 split, you will get two shares of stock for every one share you have, but the price per share will be cut in half. After the stock split, then, you will own 40 shares of stock valued at $50 per share. Think of a 2-for-1 stock split as somebody giving you two five-dollar bills and you giving them a ten-dollar bill. You end up with two bills, but the total dollar value of the money you have has not changed. You got two $5s for a $10.

Companies may chose other ratios for splitting, for example, 3-for-1 or 3-for-2.

Why do companies split their stock? Splitting makes the price of their stock cheaper, so it is more affordable. They hope people will then buy more of it, which will cause the stock's value to increase.

Why would a stock make a temporary dip in price following a split? Once a stock split is announced, traders often start buying shares, which drives the price up a few weeks before the stock is scheduled to split. Once the split takes place, traders begin to sell their shares to lock in profits from the presplit price run-up. Historically, stock splits were a nonevent. A split is nothing more than two $5s for a $10. But, in recent years, a split has been perceived as a positive move, because stocks that announce splits have usually been very good stocks. So, the stock often goes up when a split is announced because people buy into what they think is a positive move. Once the stock splits, some traders sell their stock to capture a small profit from the stock price rising between the time of the announcement and the actual split date. That selling may cause the stock price to take a slight drop. This often happens within the first three weeks following the split. After the dip hits a bottom, the stock price may begin to rise again. There is a tendency for the stock to regain lost ground and head up toward its previous high (which may take a year or two) if it is a good company, which is why the stock went up so high in the first place.

Buying a stock on the slight dip after a split is an opportunity to buy low, and when the stock begins to climb shortly after that, to sell high.

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