Catching falling knives has become a profitable activity.
It’s a strange thing, really. For most of the past 40 years, traders have been advised to avoid trying to catch falling knives. Stocks that drop sharply overnight, like a falling knife, tend to drop even more in the days that follow.
So, the smart thing has always been to step out of the way. Avoid the temptation to try to catch the knife. And, save your portfolio from getting sliced.
Avoid These Sharp Falls
The action in Adobe Systems (ADBE) earlier this year provides a good example…
The two red arrows on the chart point to obvious “falling knife” events. While ADBE shares bounced briefly after each of those events, the stock went on to slice even lower – thereby cutting up the folks who attempted to catch them.
That is what typically happens. That’s why there’s an old Wall Street saying that goes, “Don’t try to catch a falling knife.”
Now though, something curious is happening…
Look at the chart of ADBE again and notice the sharp drop at the end of May. Surely that overnight decline of nearly 9% qualifies as a falling knife, doesn’t it?
But look at what happened next…
Catching that falling knife at the end of May would have generated huge profits in June.
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Keep Track of Evolving Patterns
Of course, we could argue this was the exception that proves the rule. ADBE had been falling all year. The falling knife at the end of May was duller than the previous falls. So, it was “safer” to try to catch it.
Okay, for arguments sake, let’s agree with that premise. But, how do we explain these “knives”…
Granted, these are only a few examples. And nobody is going to argue that rushing in to buy stocks that have fallen dramatically overnight is a “safe” way to invest.
But the stock market does evolve. Patterns that used to play out all the time tend to lose their consistency.
Heck, just look at the old adage, “Sell in May and go away.” That’s not working out so well this year, is it?
So maybe, just maybe, trying to catch a falling knife might be less dangerous today than it was a few months ago. After all, the market does seem to be evolving.
Traders should keep an eye on this possible trend change in the months to come.
Best regards and good trading,
Jeff Clark
Editor, Market Minute