A few months ago, sister channel Apple Maven asked a relevant question: what has been the best time to accumulate (AAPL) - Get Free Report shares? Now, the Amazon Maven proposes the same question, but with a focus on Amazon stock (AMZN) - Get Free Report instead.
The proposed strategies include buying shares of the e-commerce giant on any given day when the following criteria are met, and then holding the stock for one year:
- Anytime, regardless of price
- Near peaks (i.e. 10% or less)
- After 15% corrections
- After sharper corrections of 30%-plus
- Above the 200-day moving average
Just for fun, and before moving on the results, I have asked Twitter for a guess on which of the strategies above would have worked best historically. Here are the answers:
Classic “buy the fear”
The old saying “buy the fear, sell the greed” should seem intuitive to most investors. If a stock is believed to move higher over time, it should be bought when there are overwhelmingly more sellers in the market pushing the price down. But does the data support the idea?
The chart below shows that, buying Amazon stock on any given day and holding it for a year, would have produced median annual gains of 33% over the past two decades – i.e. roughly since the dot-com bubble burst. That is not bad at all.
However, doing the same only after shares have undergone a correction of at least 15% has resulted in even higher gains: 42%. The median one-year return of buying Amazon stock after a 30% correction has been even better: 79%!
The following logical question in my mind is: how often does AMZN correct 15% or more, thus opening a window of opportunity to buy shares on the cheaper? Considering how fast and far the stock tends to rise, I would think that these dips are hard to come by. But it turns out that they are not:
- In 41% of the trading days over the past 20 years, AMZN was in a 15%-plus correction.
- In 16% of the trading days over the past 20 years, AMZN was in a 30%-plus correction.
Caveat #1: the bubble burst case
Having said the above, one other crucial point should be made. Buying dips works when a stock has the tendency to move higher over time. Amazon has been an immensely successful company and stock, which is why accumulating shares on the cheap has worked so well.
Now think of Amazon stock itself, but before the dot-com bubble burst. Between December 1999 and October 2001, AMZN declined by a gut-wrenching 94% from its all-time high. Buying the correction anytime in 2000 would have produced painful one-year losses.
Therefore, if an investor is fearful that Amazon shares might be trading at bubble-type prices, or that there is a significant risk that the company and stock may be unsuccessful going forward, buying dips on AMZN would be a terrible move.
Caveat #2: bumpy ride and emotional toll
(Updated on June 1, 2021)
As much as buying dips may sound like a good idea, doing so is harder than theory would suggest. This is the case because low returns tend to correlate with high volatility. In other words: the deeper into a correction Amazon stock is, the more likely it is that shares will behave very erratically.
The scatter plot below helps to illustrate the idea. The x-axis represents Amazon stock's drawdowns from the previous peak. The y-axis represents AMZN's prior 30-day volatility, annualized.
Notice that, whenever shares are in the gutter, volatility tends to be high. This is important to acknowledge because of human behavior and emotions.
Trading stocks during periods of sharp losses and pronounced day-to-day share price movements requires nerves of steel. It is easy to imagine an investor buying AMZN on weakness, seeing the share price take a large hit, and selling instinctively, out of fear.
Therefore, buying the dip can seem simple from a distance, but not so much "from the front lines".
Amazon stock: the best strategy
Stocks tend to rise over time, which is why it is generally a bad idea for investors to stay out of the market altogether. Therefore, rather than only buying Amazon stock after corrections, I think it is much more reasonable to overweight AMZN when it dips, and underweight it when shares approach a peak.
Think of a portfolio consisting of 50% S&P 500 (SPY) and 50% Amazon stock, and consider it the base-case strategy. Now, compare its performance against a portfolio that shifts its allocation as follows:
- 75% AMZN and 25% SPY when Amazon stock is in a 15% correction;
- 25% AMZN and 75% SPY when Amazon stock is within 10% of the peak;
- 50% AMZN and 50% SPY otherwise.
The chart below compares the performance of both hypothetical portfolios. Notice that shifting exposure to Amazon stock when it declines has historically proven to be a smart move: 150 basis points of extra annualized returns compared to the 50/50 static portfolio.
Explore more data and graphs
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(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting The Amazon Maven)