The Right Way to Pick Bottoms in Stocks

01/03/2013 6:00 am EST

Focus: STOCKS

Jeff White

Founder, TheStockBandit.com

Jeff White explains how he "catches a falling knife" without taking big risk to find the bottom in stock charts.

We often hear that you don’t want to catch a falling knife.  Well, I’m here with Jeff White and I want to ask you a question.  Is there a safe way to bottom fish for value stocks?

Yes, if you’re doing it the right way. And you’ve got to be very careful.  Downside momentum can be extremely dangerous and I’ve learned that personally a number of occasions and I’m sure that the people watching have learned it as well, but the issue with trying to buy a stock during a correction is that it’s still ongoing and it’s very easy to step out in front of that proverbial freight train and get run over and next thing you know, you’re trapped in a position. You now need the market to come back and help you to bail you out and you’ve missed an exit and you’re now stuck holding something that you don’t know what to do with.  Currently we’re in a market correction.  Many stocks have pulled back from their highs.  It’s easy for the novice trader to look at a chart and say, here’s a stock that’s trading at a much lower price than it used to.  It must be cheap.

Right, and let’s say Sam, I’m not looking at a garbage stock but let’s say that I’m looking at Apple in 2012 and I’ve seen Apple fall.  I’ve seen Google corrector.  I’ve seen a company with revenues and good management and other things that I know are good but I’m afraid to get in.

Right.  I think the first thing you do is when you’ve identified that candidate, you understand that the price action is what will ultimately pay you so a good company is fine to invest in but the fact is, timing your buys and sells will be a matter of price, so what you really want to do is not step out while the stock is still weak.  Give it a little bit of time.  Be patient, wait for some stabilization and what I really like to do is not necessarily look for a certain retracement off the high and it’s not so much of seeing a big bounce off of the initial low, I want to see the next pullback get bought.  I want to see some support emerge, some buyers start to step up and play their role and produce that higher low scenario on the chart.

I love it when we get technical here.  So you’re talking about a stock dropping, finding some stabilization but not rushing in at that moment.

Right.

Because we’ve got a freight train on our hand here.

Absolutely.

But if we see that bounce and then some stabilization, that’s where you’re looking.  That second bounce from there maybe is a safer place to give it a shot.

Absolutely.  I think the mistake comes people look to buy into weakness, and I think they’re much better served.  It’s a lower risk; it’s a much better potential reward to buy after some weakness.  You buy after a pullback, not necessary into the weakness and so I think that that can be very dangerous if you’re stepping in while it’s still correcting, but if you wait for some stabilization, some signs that maybe there’s a shift of character starting to take place with that higher low, then you’ve got a much better candidate on your hands.

Well sometimes, Jeff, the best time to buy is when the rest of the world is fearful and that’s some great advice about how to do it. 

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