catching a falling knife

what they say

American stock market sayings tend to be earthy and fatalistic, like “what goes around…”, or to refer to ursine gustatory “sometimes you eat the bear…” or waste evacuation practices.  Colorful, maybe, and consoling, but otherwise not very practical.

British financial clichès, on the other hand, are somewhat more high-tone but equally useless in practice–think:  “jam tomorrow,” or “horses for courses.”  One exception:   trying to catch a falling knife.  It’s a gruesome and appropriate image.

catching a falling knife

Catching a falling knife means buying a stock that’s going down in flames, while the downward spiral is still in progress.  It’s never a good idea.

On the other hand, however, if the stock in question has any intrinsic merit, there must come a time when it’s right to buy it.  And, in my view, that certainly shouldn’t be only after it has recovered, say, half of a 30% decline.  So there should be–remember, I’m an aggressive investor–a time when it’s right to behave in a way that looks a lot like grabbing for a blade in freefall.

To my mind, there are two aspects to any substantial stock/sector/market decline.  One is valuation, the other emotion.


This is the realm of fundamental analysis and is the more straightforward of the two.   Many times, stock declines begin when valuation is stretched and end when valuations are more reasonable.  This is what market corrections are all about–to provide some financial incentive–say, the possibility of a 10% gain over the coming year–for new buyers to act.

But valuation isn’t enough.

At the very beginning of my Wall Street career, I talked with everyone I could find who had experienced the market collapse of 1973-74 first-hand.  One of the portfolio managers I worked for in the late 1970s told me of buying stocks in mid-1974 for less than the net cash on the balance sheet, only to see them continue to fall, by another 10%-20%, over the ensuing six months.

Look at price charts of just about any stock today to get a more current example.  Look at their prices at the market low in March 2009.  Many were changing hands then at under 10% of the current quote.  How so?  People were scared out of their wits–something that always happens at market lows–and unable to function objectively.


This is all about technical analysis, gauging the level of investor fear/greed.

For me personally, a stock has to be trading at an attractive price on fundamentals before I’m willing to start the very subjective, voodoo-ish process of trying to figure out whether negative emotion surrounding a stock/sector/the market is mostly exhausted.

I look at:

time, since fear always takes longer to abate than I’d expect

trading volume, since sometimes downdrafts end with a final high-volume rush to sell

–the extent of the decline

–hints that the stock is finding a level below which it doesn’t want to go (this is risky, since the stock may only be two or three steps down a flight of stairs).

why write about this now?

I think the selling of “concept” stocks that we’ve seen over the past couple of months is over, and it’s time to sift through these names carefully in a more than nibbling kind of way.



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