Avoid Shares With A Big Daily Drop In Price Or Falling Knives

Falling Knives are shares that drop and drop despite many reasonable reasons that the drop is too great.

They can be shares mostly held by retail investors who over-react or shares held by institutions whose computers over-react.

Sometimes you are wrong and the market is right and the company is in trouble.

Fantasy Profits Or If Can Buy The Shares Should I?

The objective of this strategy is a consistent small growth, this is quite boring.

So a 20%-40% plus drop in the share price after a piece of bad news appears to be an attractive way to get a boost.

If you are tempted by these types of share you will usually find that you can only buy them in small quantities, if you can buy them in large quantities then this may be a sign that existing share holders have no faith and have sold up rather than sit it out.

Dead Cat Bounce Or Not

There are a surprisingly large number of occasions where a company's share price will drop by 10%-40% at the start of the day or overnight, for a reason that doesn't seem to justify such a drop.

So, "hey here is a quick and easy boost to my pot", just buy some for the day as there is always "a dead cat bounce".

Actually no, this is not always true, in fact there often isn't a bounce.

If you wait for the start of a bounce then buy in you may find that the bounce that you waited for is all that there is and the price starts going down again, if you don't wait for any bounce you may find a continuous drop.

What does seem to be usual is that there is a period of two to four days after the initial drop when retail or high risk traders buy in and out and then the price settles a bit.

The price may remain at the settle level or it may continue to drop over the next few weeks depending upon how others see the drop.

If it continues to drop it could be from the buyers who hoped for a quick profit and are now getting out and from more serious holders who can't see a positive future.

Despite looking at many shares that have had a big drop I can't work out a way of determining if the drop is going to bounce back by 5% or continue to drop for another 20%, so I avoid these "opportunities".

Volex (VLX) in Dec 2012 is a great example of no bounce and Premier Foods (Jan 2013) is a great example of a small recovery, a change of head honcho triggered a big start of day drop followed by a small recovery, then another 15% drop over the next few days.

A 15% drop represents the profit of seven weeks plus of trading, it's too large a loss for the possible upside.

Remember, you are not doing this for entertainment, that 15% loss has probably set you back by two months.

Example Of Immediate Partial Recovery - Sports Direct
Sports Direct Share Price Drop Chart

10 May 2019 - 8 Aug 2019
Sports Direct had been seeing a decline in its share price as a result of bad performance from the non core business, the loss of Debenhams, House of Fraser doing badly etc.

There was then a delay in announcing the results by a few days and then on the day of the announcement there were further delays until close of business.

These results were generally okay for the core business, but many of the new buys were doing badly and there was notification of a £600 million tax bill from the Belgian tax authorities. The results did question if all or any of this would ultimately have to be paid.

This tax bill was a bolt from the blue and represent 2-3 years of profits from the core sportswear business.

Example Of No Immediate Recovery - Aston Martin
Aston Martin Share Price Drop Chart

10 May 2019 - 8 Aug 2019
Aston Martin announced that the results about to be published would not be good causing the drop down to around 600p and when the results were announced the price drop continued down to around 450p.

Prior to this the share price had steadily dropped from 1700p to 1000p and seemed to have stabilised there.

Even more surprising only a few weeks before the results a major share holder had announced that they were adding another 3% of Aston's shares to their holding at 1000p.

In the charts the thick line is the share price, the red line the percentage change in the last 14 days and the grey line the percentage change since the start of the chart