Investor Facts: What Is A Falling Knife

A falling knife is investment that is falling rapidly in price.

Investments such as stocks can be subject to unpredictable price swings. The breadth of those swings up and down in price is known as the investment’s volatility.

A volatile stock can fall (or rise) in price dramatically. Investors naturally prefer to buy low. But it’s hard to say where a stock will cease falling and again rise, or if it will at all.

Many investors like stocks that have declined in price. Buying good companies at temporarily depressed prices is a reasonable strategy, known as value investing.

An otherwise good investment that is declining in market value thus might become attractive to buy — so long as it does not continue to fall after purchasing.

If it does continue to fall the investor runs the risk of selling at an even lower price later on, largely wiping out the initial investment.

The investor has become victim to panic selling, an emotional reaction to potential loss that results in actual loss of capital. That’s the “falling knife” in the warning, “Never try to catch a falling knife.”

Bottoming out

A falling knife is a fun slang term used primarily by investment professionals and especially portfolio managers in the investment industry.

It’s called a falling knife because trying to catch it at or near its lowest price can cut you! Even in the case of aggressive, speculative investors attempting to “catch a falling knife” is usually not worth the risk.

The fact is, it’s nearly impossible to catch the absolute bottom of an investment’s price action.

Rather, it is advisable to instead wait for a crashing investment to bottom out, find its legs and gain some upward traction prior to adding money and opening up a position in your portfolio.

If you manage to catch a falling knife, remember, you got lucky. Never confuse investment luck with skill or accomplishment!

MarketRiders, Inc. is a registered investment adviser.  Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies.  Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.