Sunday, January 24, 2010

Catching Falling Knives In Bearish Trends Is Very Dangerous!


One lesson i learned the hard way many years ago is that trading a 'falling knives' type of strategy in bear markets or strong bearish trends is very dangerous(especially for those of you who not use stops with discipline!!!).

This strategy is a good one in bull trends/markets as prices are quickly bought up by new buyers but what happens when the buyers are not there any more????

Well, an avalanche of lower stock prices hits the tape and the stock will collapse much further then you even imagined! If you are using stops, then you will say: "Thank god for stop losses" and you are very smart!!

However, If you failed to use a stop then you failed miserably!! Because now, you are now stuck in a whirlwind of lower prices and all the mental drama that comes with it. That's when all the mistakes you were told to never make will be made:
You will tell yourself things like:

1. "I will continue to average down to lower my cost basis."
2. "i will sell it for a small loss once it bounces a little."
3. "i will make it a longer term investment now."
4. "we are oversold and it is going to bounce soon."

This is exactly the wrong way to look at things when things are not going your way!! This is an amateurish way of trading. You will not survive for very long if you are running your trades this way. Think like a professional and what ever strategy you decide to use: USE STOPS WITH DISCIPLINE!

Attached is a chart of YGE that illustrates this very example of how in bearish trends, "oversold" becomes more "oversold" and the big bounce never comes when you want it:

good luck.

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