What does “don’t catch a falling knife” mean?

The term “don’t catch a falling knife” is a common term used which means the share price may drop further. Trying to catch a knife that is falling is, of course, a dangerous thing to do and could lead to some bloodshed. Therefore, wait for the stock price to bottom or you could incur further losses.

Falling stock prices

Don’t catch a falling knife basically means you don’t want to buy a falling stock as it may continue to keep falling and you will be left with more losses. The problem with buying a falling stock is when does the stock stop falling?  It may seem that investors are getting a great price at these cheap levels but what happens if the price falls continues. Stocks may drop significantly in value an announcement is made to the public which may be unexpected. Once the selling starts and the volume is heavy, there may be a knock-on effect where other stock holders are watching the price and start to panic as well when they see the value go down. This exasperates the falling stock price further and we see levels becoming even lower and perhaps falling support levels.

Support Levels

A support level is floor that the stock price will hold in at that point in time. It can come about for a variety of reasons, sometimes it might be a round number that or a valuation metric that in the past has seen investors happy to pay for that particular company. Once a stock falls through a support level a new low may be found for that stock.

Value Investors

Value investors may want to take advantage of a falling stock if they are intending to hold the stock long term. If they see the company as fundamentally sound they may want to buy the stock while it is cheaper and wait for the stock price to head up higher.

Delisted Stocks

The danger with falling stocks is often there are major fundamental problems with the company. This can sometimes cause the share prices to drop to zero. On the below chart you can see the share price of Blue Sky Alternative Investments (ASX:BLA)  drop to what seemed like bargain levels, but never recovered.

Lauren Hua is a private client adviser at Fairmont Equities.

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