Don’t Catch a Falling Knife When you Can Trade the Trend

“Don’t catch a Falling Knife” is more than just a funny saying, it is a philosophy. Instead of trying to trade the trend a lot of people simply go out looking for spots where the old trend will end and a new one begins.

I once heard a story about two investors sitting in a restaurant arguing weather it is better to trade with the trend or against it. The waiter next to them tripped and the knife he was caring flew into the air. As the knife started falling down one investor stuck his hand out.

The knife fell down and stabbed his hand. When the other investor asked him why he did that he replied, “I thought it was going to stop”

Now you may laugh but there are people using this same philosophy in the stock market. Thinking while it is not wise to get in front of something that is falling in the real world somehow it is smart to do it in the stock market.

It isn’t hard to see why; it looks appealing to get into a stock that has just been cut in half, or worse. Companies like GM, LEH, FRE, and FRM who were stable companies looked like a very good deal when they were at $5. They looked like an even better deal when they went to $2 and $1.

I’m sure most people would have thought differently had they known what was going to happen to these strong companies.

That doesn’t mean that it is always a bad thing. Some stocks do turn around and start trending up, but why risk it when you can go out and find a stock that is already trending upward.

Trading with the trend definitely has its advantages over trying to catch a falling knife.

1. Faster Profits

You don’t have to wait for the stock to bottom out before you make your money.

2. You can cut your losses

If you buy an up trending stock and it turns around you can always get out of it and cut your losses short. If you try to pick the bottom the stock it only looks like a better buy as it goes lower and lower.

3. You can make money both ways

Bottom picking helps you make money if the market goes up. But if the market goes down that is going to work against you. If you trade with the trend on the other hand you can make money regardless of whether that trend is going up or down as long as you stay on the right side.

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