How to “Catch a Falling Knife” for Big Profits
How to “Catch a Falling Knife” for Big Profits by Justin Spittler – Casey Research
Justin’s note: The markets and our offices are closed in observance of Labor Day. So for today’s Dispatch, I want to share a classic piece from our colleague, master trader Jeff Clark. Below, Jeff shows how you can find when a stock has hit bottom… and score a windfall profit from its recovery…
By Jeff Clark, editor, Market Minute
Most traders are familiar with the cliché Wall Street warning of “don’t catch a falling knife.”
You see, buying into a stock that is falling sharply is generally a bad idea. While picking the bottom of a stock can lead to massive gains… if you buy at the wrong time, it can also lead to big losses. And, frankly, most of the time… that’s what happens.
But there are times when the knife is so close to the ground – where the risk of further loss is minimal, and where the potential gains are so enormous – that it makes sense to reach out and grab it.
Today, I’m going to show you how to find these setups…
Let’s start by looking at an example. Take a look at this chart of Lululemon Athletica (LULU), the sports apparel manufacturer known best for its line of yoga clothes…
Back in December 2013, LULU shares dropped nearly 20% overnight (point 1 on the chart) in reaction to some bad news from the company. Now, it doesn’t matter what the actual news was. The important thing to recognize here is that this was NOT a good time to buy shares of LULU. Bad news is usually NOT a one-time event. There’s almost always a second shoe to drop.
So if you want to profit from “falling knives,” the first rule to follow is to never buy a stock on the first decline from bad news. There’s usually more trouble to come.