April 30, 2020

Never Catch A Falling Knife

Never Catch A Falling Knife

Click here to get a PDF of this post

When a market’s price action falls straight down making lower lows continuously without stopping or bouncing back it is considered a ‘falling knife’ on a chart because of its speed and trajectory. It’s not a good idea to buy into a chart with plunging price action that can’t find support before there is a signal or a good reason to do so.

Just because something is falling fast does not mean it can’t go lower or it is an opportunity to buy at lower prices. Low prices can go much lower before finding support with new buyers at key lower price levels.

A price falling dramatically is not an opportunity a quantified signal to buy the dip can be.

The odds of buying the dip is better when a chart first stops going lower, finds support, and then starts going up. Waiting for a reversal can lead to a little higher entry price but a better chance of success in a reversal.

Things fall for a good reason, nobody wants to buy it at current prices so the stock falls looking for the price level the buyers are waiting for. 

Down trends that are in motion tend to keep going lower as it is the path of least resistance. 

There is a big difference between buying the dip and catching a falling knife. One can give you a good risk/reward ratio entry the other can cut your account to pieces as it keeps falling.

Some charts do go to zero or never go back higher again. Companies go bankrupt, penny stocks can be scams, crypto currencies can be worthless, and option contracts can expire worthless. Even oil futures contracts can go negative. It can increase your odds of success to buy things with built in value that have some intrinsic value. 

There is a big difference between buying the dip and catching a falling knife. One can give you a good risk/reward ratio entry the other can cut your account to pieces as it keeps falling.

Don’t try to catch a knife by its blade while it is falling wait for it to first stick in the ground and then pick it up by its handle.

Never Catch A Falling Knife

Chart courtesy of TrendSpider.com