You probably heard the phrase “catching a falling knife” when it comes to investing. Catching a falling knife means buying an investment when it is plunging in price, only to realize later that the stock will continue to plunge or even become worthless. As the phrase implies, this can be dangerous when it comes to investing. Unfortunately, during a time when there are few stocks that are undervalued and many are overvalued, it would be too attractive to buy into stocks that are falling in price too dangerously.
One of the best pieces of advice for investors is to try to buy an investment while the price is low. Many of the best investment opportunities can be found this way, but so can the worst investment opportunities. So how can you recognize a falling knife from an excellent investing opportunity.
Do Your Research
What you read in this post is not professional financial advice, but educational advice to help you seek out good investment opportunities.
The best advice that can be given in finding good investments is to do your research. There are many things to look for when doing this. The first is to determine where the price falls within a 52 week range. If it is low that indicates that the investment is on sale. But why is it for sale? You will need to find out exactly why. Almost anything can affect the price of an investment from new products to merges to new diversification policies. But nothing affects the price like a severe decline in revenue, fraudulent activity, and lawsuits. It would be best to determine how these changes will affect the market or company and how that will affect the earnings and the price of your investment.
Another thing to consider when looking for a falling knife is to see how the company plans on dealing with the lower price. If the company is doing very little, then the company is not innovating and it is less likely to grow. If the company is putting efforts into innovations, then it will likely grow. The stocks of any company that is not growing is a falling knife.
What Type Of Low Are You Dealing With?
When I was choosing stocks I found that many of the best stocks that grew had recently had 52 week lows, or close to it and rebounded. Now many of these companies are facing new highs, even in some cases where the price dropped significantly in a short time.
But should you buy companies with 3 year, 5 year, or even 10 year lows? Those should be red flags to you. That means people have been concerned for more than a year about the stock. The only time that a company is facing these lows with little concern about the stock itself is during a market correction or a recession where people are more concerned about the overall market instead of the individual company.
Are You Buying For Value Or Price?
You should be cautious about buying a stock after a correction or a recession. I go by this rule: if you were not considering buying a company at a higher value, why would you buy it at a lower value? You must determine whether you should buy the company before it goes on sale. If you want to buy a company that is on sale merely because it is on sale, you are buying for the thrill of buying, not unlike a Black Friday shopper trying to get a crock pot or TV on sale when they see no value in it for themselves.
The reason for this is because you should buy these stocks for their value not for their price. Value is how much the investment will give to you, price is how much you have to give to the investment. It is easy to confuse the two for most people because separating one from the other can be hard. This can happen because society has lied to us that price and value have no difference, which makes it hard to avoid catching a falling knife.
How To Identify A Falling Knife
There is no universal way to identify a falling knife. In fact, if you want to invest, or already are investing, it is best to accept that you either will, or already have caught a falling knife. The key to being a successful investor is to catch as few falling knives as possible while catching more excellent investments. You have to do your research and go with your instinct.
For instance, there are two particular companies that my instincts are screaming not to buy. I will not mention their names because I want you to make your decision on investing by yourself, but I can still share my opinion. One of these companies is a specialty retail store that has reached decade lows. It has even reached the status of penny stock earlier this year. Unfortunately, it has not adapted to survive the “retailpocalypse” and many of their employees have complained about their jobs and the ethical policies about the company. The other is an energy company which has also reached decade lows. It has faced constant lawsuits and while it has tried out using natural gas, it has not moved pass oil too much. At least for now, I am keeping my investments as far away from these two companies as possible.
Falling knives can be lethal decisions in investing, but not as deadly as the name implies. You may catch these if you invest, and you should invest if you want to forge your wealth. All you can ever do is try to avoid them, but if you try to find quality stocks, it is unlikely they will be falling knives.