Falling Knife - Stocks

A falling knife is a security which has a steep decline with virtually no counter move on the way down.  Falling knife stocks have been a vice for a number of traders for a long time.  There is something within a trader's nature that forces him to step in front of this freight train.  The issue with buying a falling knife is that they are dropping like a rock for a reason.  Stocks fall at an accelerated rate right before a bankruptcy or after a horrible earnings report.  The odds of being able to pin point the exact bottom of a falling knife are slim to none.

How to Catch a Falling Knife

Becoming a winning trader is about having patience.  Catching a falling knife requires enormous patience and control of one's emotions.  A classic method for buying a stock that is falling swiftly is to wait for climatic volume.  A pickup in volume of 500% or more will often flush out the strongest of longs, thus leaving no one left to sell.

Example of a Falling Knife

The summer months of 2008 have proved brutal for the financial markets.  Below is the chart of Freddie Mac (FRE), which is a perfect example of a falling knife as it fell from $25 to under $4 in less than a month.  Notice how the volume spike preceded a 100% reversal off the bottom.