how to recognize a falling knife?

[anitya]

“When the train leaves the station, it doesn't back up to let latecomers on. If it does, there's something wrong with the train."



- Walter Deemer

[mani]

I find it pretty easy to recognize.
I buy if first, then buy again when 20% lower (because now it's cheap right?) then buy again 20% lower.
Then at that point I look at my bloody digits. Yup, falling knife.
I'll usually hold though then sell when it get close to where I bought them, telling myself "I lost nothing" while my money went nowhere for a year or two

[steelpony10]

    Irrational exuberance and greed go hand in hand, an overreaction to an earnings report and how skilled a spokesperson handles the situation. So its always management.

    Stellar companies will bounce back eventually due to management talent and are true sales. Poor companies change management or hire a turn around specialist like Ford, GE and BA did in the past creating a leap into the unknown. Prior knowledge of management helps while poor companies take a long time to come back.

     For long term safety I stayed on the most part to those having proven managements. I did take a chance on a few questionable situations trying a technique I learned through Better Investing. The results were clearly that I stink at that. I did learn another one of my limitations though which is why I don’t trade.  I did take a questionable flier with AAPL and MSFT in the late 80’s, new companies, because of indecision on my part during a discussion with an investing mentor. Dumb luck works out occasionally. Probably NVDA and patience long term would fit that situation now.

[uncleharley]

The following URL will take you to an article by Arthur Hill of StockCharts explaining how to play a falling knife pattern. The pattern is also called a Means Reversion.

stockcharts.com/articles/arthurhill/2024/01/putting-a-meanreversion-strate-723.html

[howaya]

" Stellar companies will bounce back eventually due to management talent and are true sales. Poor companies change management or hire a turn around specialist like Ford, GE and BA did in the past creating a leap into the unknown. Prior knowledge of management helps while poor companies take a long time to come back."

Perhaps a case study could be useful for this discussion. Three years ago DIS (Disney) stock hovered around $200/share. Was the run up largely a Covid-driven phenomenon? By January 2024 it dropped to ~$90/share. Bob Iger returned to lead the company out of its malaise in November 2022, and so he has had more than a year at the helm; we see positive results only within the last month, now that the stock is trading at $111. Has that been enough time to expect better, is the positive move sustainable, are competitive factors and a changing environment manageable, etc, etc? Do stellar companies sometimes falter and never recover? Or is this the beginning of a great buying opportunity?

I could pose the same questions for any number of other well-established companies and yet the correct answers remain anything but clear.

[anitya]

We all know and remember direct consequences of catching falling knives. But there are very many second order effects. E.g., because of the traumatic memory and anchoring bias, many falling knives get sold too early if they turn out to be good recoveries. I think it is always good to make sell decisions independent of buy decisions / experiences. There is always a huge difference between knowledge and practice.

Share any other second order effects you experienced.

P.S.: most of my sharing is to improve myself.

[richardsok]

Mar 2, 2024 18:54:21 GMT anitya said:

We all know and remember direct consequences of catching falling knives. But there are very many second order effects. E.g., because of the traumatic memory and anchoring bias, many falling knives get sold too early if they turn out to be good recoveries. I think it is always good to make sell decisions independent of buy decisions / experiences. There is always a huge difference between knowledge and practice.

Share any other second order effects you experienced.

P.S.: most of my sharing is to improve myself.

Catching ahold of bull trends and avoiding falling knives are performed most successfully when the investor limits himself to low volatility assets to trade while he tweaks his chart set-ups to arrive at a workable compromise between fewer signals per year yet with catching signals that really matter early enough to avoid sharp losses and to participate early in rallies.

TOP:  StockCharts modified so that the actual price line is invisible.  All that remains are the 2-day MA and the 13-Day MA with the P-SAR overlaid.  My goal is to have few but unmistakeable trade signals. 

Bottom chart is from ThinkorSwim, true price line invisible.  Shown is the price line at two-day intervals with the PPS indicator overlaid.  (With the poor image quality, it may be hard to see the "buy" signal that appeared in November.)

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[steelpony10]

richardsok ,

     “Low volatility assets”. +1

[richardsok]

Mar 2, 2024 21:08:55 GMT steelpony10 said:

richardsok ,

     “Low volatility assets”. +1

 
A third alternative is to apply the HEIKEN-ASHII SMOOTHED indicator on barchart.com.   I find it can make overly volatile assets tradeable.
Here I chart PDI (notoriously difficult to trade b/c one is always tempted to hang onto the distribution stream). After the last few months you can see why I started selling several weeks ago, completing my final sale just the other day.    The H-Ashii Smoothed gives you clear indication when a strong upward momentum breaks down into directionless volatility.

All this was covered in my book.  FD1000 predicted that no one would pay attention.   (I think he was right.)


www.barchart.com/stocks/quotes/PDI/interactive-chart

[FD1000]

Here is the problem with
1) Every time it goes lower I buy more...it means
What happens if the market went down 10% instead of your target 20%=adding more, or maybe it was down 18% and you missed the opportunity.
What happen if the market went down 20% and you buy more, and it went down another 10-20% as it did in 2008-2009

2) Use RSI 10 + wait for it to go under 30 and buy when the bounce occurs.
What happen when it goes to 25 and bounce?
What happen when it goes to 30, bounce a bit, you bought and it goes back to 30.

The above means
1) You have cash on the side = this cash didn't participate when the market went up. Since Nov 1, SPY went up about 23-24%.
2) You also would make a lot more trades that could lead to one trade every week when you have several holdings.
3) Many of these traders will make small % trades which in most cases would not influence their total performance and/or risk.
4) Unless you have a proven record over several years that your trades achieved a significant better risk-adjusted performance, why do it. Most investors should know their goals and invest mostly in wide range indexes and some managed funds and hardly trade.

Rich, I don't predict markets, but I can predict human behavior. Investors always discuss trading after the markets plunged, instead of when volatility is lower and markets are "normal".  Many investors don't understand that you must have a complete system, and not only for one aspect of trading. I have tested hundreds of possibilities and could not find a simple easy solution, and why it took me years to tweak and get it right...and I'm never satisfied.

[steelpony10]

richardsok ,

       I’m sure you’re a well versed experienced trader Recently I saw two guys make trades in 30 second commercials on cell phones. Apparently you can “like what you see” that quick now. One chart shows the value going up and an independent opinion apparently likes it also.

        My own library research along with holding long term world is gone. Draft Kings is everywhere now.

      

[archer]

richardsok, What Low vol funds do you like to work with using your system above? I remember you mentioned a few in your book, but perhaps you have found more.?

The chart for USMV doesn't impress, as I think you mentioned back when you first introduced your book.

Thanks,

[mnfish]

I've had some that worked by buying lower and lower - AAPL(2012-13, largest purchase I've ever made), FAST(08-09)(sold in 2012), ORCL(90s), META (bought twice in 2022, $195 and $95), sold in 2023)

and some that haven't - RIG, LINN Energy(now private),

I'm sure there's more but these stand out from memory. Some I sold too soon (FAST, META), and others not soon enough (RIG) and some you just hold (AAPL mostly, ORCL)

How do you know if it's going to turn into a knife? It's easy in hindsight.

[racqueteer]

Not to appear overly glib, but you kind of only know you're catching a falling knife after it punctures your heart!

[FD1000]

Why slower moving funds are easier to trade. Just one example (all on my site).

I sold on 2/29/2020 just days before the meltdown because of Covid=unique situation(community.morningstar.com/s/question/0D53o00005E8YIDCA3/sold-most-of-my-portfolio-to-cash). I made a similar post at (www.mutualfundobserver.com/discuss/discussion/55299/bond-mutual-funds-analysis-act-2/p2)

It also showed on the chart since I use the big picture above + charts. Let's look at Q1/2020 for NHMAX(a fund I held at that time) + SPY. NHMAX gave me another week to get out while SPY was already down more than 10%.

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[fritzo489]

Does the above info apply to mutual funds also ? I'm still bleeding from a few MF's I purchased.

[richardsok]

MFs are relatively cumbersome to trade unless you are using very long & slow signals, say 50 x 100DMAs or so.  Management discourages nimble traders and one must always wait for the day's close to get your execution.

[richardsok]

Mar 3, 2024 0:47:56 GMT archer said:

richardsok , What Low vol funds do you like to work with using your system above? I remember you mentioned a few in your book, but perhaps you have found more.?

The chart for USMV doesn't impress, as I think you mentioned back when you first introduced your book.

Thanks,

archie --
     



Funny you should ask. At first, you will recall. I opted for AOM because it appeared logical that an equity/bond mix would of course behave calmer than pure equities alone.


Norbert took me to task, showing that one sacrificed too much in gains trading AOM according to signals as opposed to simply holding SPY. At the time, I argued that the average retail investor would NOT hold SPY in a bear market; rather s/he'd be inclined to sell at the worst possible moment.

But with time, I came to see his point. I have been trading AMOM for the past couple of months with good results. Recently it occurred to me that we are at the top of an extended bull market, and it might be a good time to compare how various ETFs I've been fiddling with have actually behaved.

I drew the sketch below to illustrate the six-month gain numbers from Schwab. The numbers in RED show total % gain in the last six months (not including dividends). First thing I see is that SPY itself is actually not so bad – but my goal here is to find which ETFs performed better or similar to SPY but, hopefully, at reduced volatility.


Second surprise: AMOM turned out to be MORE volatile than SPY, though I was able to trade it

Third thing I notice, those funds which outgain SPY became ever more volatile as performance increased.


I would say (tentatively!) that the colored highlighted funds seem best to trade. Though JEPQ lags in gains, it becomes competitive with strong distributions.


Next observation: remember this is near the highs of a bull market. Experience (and many past charts) have shown to me that volatility increases on the way down.


I use the term “VOLATILITY” even though it does not exactly measure what concerns me. If XYZ takes three days to erode 6% but DEF apt to drop 3% at a day's opening and remain stagnant the rest of the three days, I'm not sure finviz wouldn't call XYZ more volatile than DEF --- but for my trading purposes DEF is surely the more problematic. I'm interested not only in the strength of short term anomalies but in their suddenness too. I don't know how well “volatility” as commonly understood, is a measure. Perhaps a better term would be “NOISE”, but then no one would know what I was talking about.
      Sorry about the graph's crudeness.   Doodling is how I roll.

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[FD1000]

The problem with low volatility stock ETFs/Funds is the fact that volatility can show up at the wrong time when markets collapse.
Example: is QQQ more volatile than SPY? Yes, but in Q1/2020, QQQ fell less than SPY. BTW, PDI=bonds fell even more. See chart below.

The only way to eliminate big losses is to sell to MM. It doesn't comfort me if my portfolio lost 20% instead of 30%. I never want to lose more than 5%.

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[liftlock]

Falling knives are not always easy to recognize ahead of time.  I have had more than my share of them.   I wish I had better discipline to avoid losses by selling positions moving into a down trend, but I have too much tolerance for losses and I am not much of a trader.  Even worse, I am guilty of holding onto losing positions with the hope they will eventually recover when I should probably sell them them and move onto better stocks. However, I find it psychologically difficult to realize losses. 

I have tried to take advantage of falling knives by doing Roth IRA conversion on them. My idea has been to get the falling knives out of my T-IRA at a low tax cost and hope the stocks recover their losses tax free within the Roth IRA.   When doing Roth IRA conversions I try to identify stocks with the largest % losses with the idea they are likely to have the largest % gains when they rebound.  This strategy has worked well overall, but I have had my share losses on falling knives that may never recover in price.  I currently hold a several securities in my Roth IRA which are down more than 40% in price (not counting dividends) including ARKF, TEVA, BSTZ, JFWD, IMBBY, TEF, ARKG, DXC, VOD, PARA. Many of these stock were down more when I converted them to my Roth.

One observation about falling knives is that they become a less important part of a portfolio as they continue to decline.  Another observation is that higher yielding stocks appear to have a higher risk of becoming falling knifes.   

[mnfish]

Maybe this will help shed some light on the "knife"

"Companies in the Dow made bigger-than-normal adjustments to their profits in Q4, analysis shows"

In the fourth quarter, among the 30 companies in the Dow Jones Industrial Average, the gap between those two types of profit (GAAP and non-GAAP) was far wider than normal
That analysis found that the median difference between per-share profit reported based on generally accepted accounting principles, or GAAP, and the adjusted kind — non-GAAP — stood at 31%. That’s far above the norm for that difference — 11.7% — based on five-year averages.
The biggest such differences in the most recent quarter could be found in companies like drugstore chain Walgreens Boots Alliance Inc. at 925%.
The spread for chemical and materials giant Dow Inc. was 386.7%. (I recently sold DOW)
Verizon Communications Inc., Merck & Co.,(I sold last year) Salesforce Inc., and Johnson & Johnson rounded out the top 10.

It’s also the fourth biggest difference between GAAP and non-GAAP earnings per share for Dow companies since FactSet began tracking it in 2016

Still hanging on to my small SDOW experiment