Don’t Catch a Falling Knife & Dead Cat Bounce

oil2
The above chart is the price of the Spider oil sector exchange traded fund (XLE). It illustrates two slang phrases used by the financial industry. Trying to predict where an investment will stop falling is a fool’s game and is a sure way to lose money.

Don’t try to catch a falling knife because knives cut people. There are very few situations when the price of a falling investment immediately reverses. XLE price started to fall in price at the end of July from $100 to $80 by mid-October. A 20% drop in price in just over 75 days illustrates that prices fall further and faster than anyone could predict. Trying to buy these drops might make you feel like a superior investor until your account gets wiped out. You may make a quick profit, or you may cut off some fingers. (now down 25% and is still falling)

A dead cat bounce is a small, brief recovery in the price of a declining investment. Derived from the idea that “even a dead cat will bounce if it falls from a great height”, the phrase, which originated on Wall Street, is also popularly applied to any case where an investment experiences a brief resurgence during or following a severe decline. XLE had a dead cat bounce up from $80 to around $88 in 30 days but resumed to fall in price. (My apologies to all cat lovers)

Before I would invest in an oil stock or an oil ETF, I would play it safe by waiting for a bottom to form. It may take three to six months or more to verify that the price has stop falling.

bottom

The chart above shows what a price bottom should look like. 

Additional factors to consider before investing in the oil market:

  • There is still a lot of fear in the oil market.
  • The so called experts are often wrong when predicting where the price of oil will stabilize. 
  • It takes time for oil companies to stop pumping out oil from existing wells. It is more complicated than just closing the tap.
  • Oil companies have make some commitments to spend money on new drill sites that can’t be postponed.
  • Oil prices are falling due to over supply and OPEC  says that it isn’t going to cut production.
  • Hedge funds are short selling oil stocks driving the price even lower.
  • Tax loss selling season isn’t over yet.

Before you invest, you need to do your homework, stay clam and be rational.

Two sites that I use for drawing charts are: http://finance.yahoo.com/  http://bigcharts.marketwatch.com/

Are you interested in more information on how to use charts to improve your investment returns? Please post your comments on this topic or email me ricodilello@rogers.com

Disclaimer: I am no longer licenced to give investment advice. This post is only for educational purposes. Please consult a qualified financial advisor before investing.

 

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4 thoughts on “Don’t Catch a Falling Knife & Dead Cat Bounce

  1. The drop in oil prices should reduce transportation costs for consumers and businesses. Air lines and trucking companies should benefit the most from lower fuel costs. If consumers use the savings to spend than the economy should continue to grow.

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  2. Great post! I’m very new at investing, especially outside the realm of retirement accounts, and this is fascinating. I’m learning about the whole ‘fools game’ of predicting the market. I even thought you made up the dead cat bounce- didn’t realize it was a thing! Thanks for the info!

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