Falling Knife

What is a Falling Knife?

As per the falling knife definition, it refers to the rapid drop in the overall value or price of some security. The given term is known to be utilized in famous phrases implying “do not try to catch the falling knife.” This could be translated to the meaning that you should wait for the prices to get to the bottom before buying the same.

A falling knife is known to rebound quickly –referred to as whipsaw. In other words, it might imply that the given the security might lose all of the value –like in the case of Bankruptcy.

What does a Falling Knife Imply?

As per the falling knife definition, the given term is known to imply that buying into the Market with abundant downward momentum can be dangerous to a greater extent –just like catching a falling knife in a real-life scenario. However, in practice, there are multiple profit points as well in association with a falling knife. When the given condition is timed perfectly, a trader who might be buying at the bottom of some downtrend could look forward to ensuring significant profits once the price would recover.

At the same time, applying for some short position due to the fall in the price while getting out before the occurrence of some rebound could also be extremely profitable. Moreover, even buying and holding investors could lead the situation of a falling knife to serve as some buying opportunity. The only condition here is that the investors should have a fundamental case that implies the stock’s ownership.

However, it is also important to note that it is a condition of real-life risk that the timing might be off and you could end up incurring significant losses before ensuring any gain. Rather than trying to hold the falling knife, it is recommended that the traders out there should aim at searching for the confirmation of some trend reversal with the help of chart patterns and other technical indicators.

An instance of such a confirmation could be something like waiting for multiple days delivering upward momentum after a period of fall or observing the RSI (Relative Strength Index) for signs related to some significant uptrend before buying as per the new trend.

Utilizing a Falling Knife

There are several ways in which you can make profits out of a falling knife. Most of the trading approaches tend to be time-sensitive while requiring more tools than the mere identification of a stock that is observing some sharp drop in the stocks. However, when it comes to the fundamental case of catching a falling knife, it might depend on the occurrence of the drop.

Some of the other potential reasons for the occurrence of the falling knife might be:

• Earnings reports
• Economic reports
• Technical breakdown
• Fundamental deterioration

If the conditions that cause the situation of a falling knife tend to be temporary, then it could turn into an opportunity.