Lessons from Falling Knife & Other Clichés in Financial Markets

I may not be the best Wall Street Investor at least I’ve no prior experience but recently I did make it my ambition to catch up with the markets. For once, life is more less the same as the financial markets. You must be decisive and make mature decisions. Over the last month, I’ve really struggled whether I should continue with this blog at least under this domain name. Change is always inevitable, I’ve acquired a brand new Domain Name and a better home is on the way, it’s being refined by a friend. I thus had to make a decision whether to have another article appear or should I wait. Through soul searching and with a couple of articles in my laptop in the waiting line, Posting has definitely prevailed.

In line with my strategy to create multiple streams of income and growing my wealth seven fold by the end of year 3, I decided to explore new investment ideas in the financial markets. And just like sports and other activities in life, investing is full of clichés that have pearls of wisdom to behold at such a time when life is so volatile. Understanding these clichés and their implications goes a long way to helping you stand out from the crowd. I have picked some of these clichés with special reference to a falling knife.

FALLING KNIFE PHENOMENA

The term falling knife is especially common in the stock and foreign exchange markets. It’s common to hear brokers and investors cautioning each other or newbies “Never try to catch a falling knife.” This cliché simply means that when a share is falling, there’s a good reason for this fall. The point is, it may continue to fall anyway and consequently do not even think buying the share until it has finally come safely to rest. What’s more? Picking up the knife may turn out to be a trap. Think of the time you started cooking and the knife slid off the counter. Times you may be luck to grab it by the handle and probably it won’t hurt you. But next time just step back with your hands when it happens. In essence treat this like a loaded gun. You may never escape with all your fingers and your sanity. 

The main trouble with falling knives is knowing when exactly they have stopped falling. It is also important to differentiate between panic selling and falling knives. The former represents shares or currencies that have fallen sharply mainly because of the overreaction to unsavory news by speculators. While falling knives may be attractive to short term traders hoping to make quick returns, they are risky as Branes Institute found out companies with Falling knives  (shares) always post higher bankrupt rates over a three-year period following the initial fall.  The upshot is that when you pick up an occasionally falling knife hoping that it will rebounds, this can be a hit and miss. On one hand, chancing your luck in a falling knife situation means that you simply decide that the price drop is a temporal situation. This conclusion may be done by justifying the price drop as a result of a market overreaction. A falling knife may never rebound and may end up losing all its value. However, a pick up that is timed perfectly at the bottom of a long downward momentum can be rewarding financially and emotionally despite risks being extremely high. My point is, in life don’t go for the trending heading southwards, capture the moment and be decisive on what to take and what to ignore.

OTHER CLICHÉS

Here are other clichés that have stood out from the crowd for me from the financial market: It’s not different this time. Financial market activities that happen each day have happened before and will repeat again. The debate is to what degree. Investors have no control over financial markets. The best they can do is recognizing the messages that the markets are conveying. Buying low, selling high has similar odds to winning the lottery. Very few investors achieve these milestones. Greed can be the Achilles heel of investors. Sell when you can, not when you must. Accept that losses are part of the investment experience. The biggest problem is not incurring losses. Rather, it’s holding losses too long. Cut your losses swiftly and decisively. Don’t expect to make the right decision every time. Emotional attachment to stocks is a downfall of many investors. Learning to be patient and logical is a difficult virtue. Wise investors can change course quickly when the time comes. Remain objective and void of biases. Bad news on a stock or a currency is often not a one-time event. More usually follows soon after. If the news troubles you, sell your stock or currency you holding.

CONCLUSION

Intrigued by the knife-catching phenomena and other trends in the financial market Nobel Prize Psychologist Daniel Kahnemmen co-authored "Thinking, Fast and Slow" with Jason Zweig a Wall Street Journal Writer and observed that predicting when a market will turn is attributed to a cluster of fundamental human traits. In particular they argued that people have a tendency of believing they have special insights that give them advantages over others. They also observed that in critical conditions such as a rapidly falling market people rely on their intuitions and the variation is only observed with flight or fight responses. When investors are losing fast, they get into panic mode and prepare for a fight or take a flight. However, they argued that they are better off by slowing down and taking time to analyze the market situation and their responses to the emerging trends.

Given the above observations and reflections, the questions you should Ask are, What Causes you to believe that you can somewhat get back when you have lost in life by a single drastic strategy in life? What are the consequences of a failed attempt to recover the area you’ve fallen in?  This is because life is fundamentally unpredictable, we cannot outperform life even when we think we have trained enough. People even who have outperformed others in a given year or facet in life may be unable to match this performance over the next year. Times when we do not have superior insights it’s important to ask for help.

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