Catching a Falling Knife
The term catching a falling knife refers to an investor purchasing a security as its price drops significantly. An investor will attempt to catch a falling knife when they believe a security’s value is about to rebound.
As the phrase implies, catching a falling knife is dangerous. When the price of a security is falling rapidly, it’s very difficult for an investor to predict when the security’s value is going to rebound. In fact, the company can go bankrupt, and its shares of common stock can lose all of their value.
Market sentiment towards the security can also drive its value down, even if the longer-term outlook for the company is improving. That being said, investors do catch falling knives successfully. When this happens, the financial rewards can be great. To increase the chance of success, the investor should ensure the company has the ability to increase earnings over the long term. That is to say, there is some fundamental reason the company’s value will eventually rise.