Bottom fishing or catching a falling knife?
The JSE seems to be filling up with bargains, as stocks have double digit declines in hours and days. Investors just need to look at what happened with Tongaat and Aspen in the past few days. And these aren't the only ones in the past couple months, Capitec, EOH, Resilient and its related companies are still fresh memories.
Very often large cap stocks with derivatives on them can react a lot more violently than large cap stocks without. This is due to traders trying to limit losses on geared positions, hedge out risk without closing the position outright or traders taking big bets against a fall lower.
Bottom fishing has two categories, event driven, like we have seen in EOH and APN and value plays, like the construction sector or mining stocks in 2016. Event driven bottom fishing doesn't give you much time to react, but you can follow the below rules to reduce your risk and increase your chance of profiting.
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3 Rules to successful Bottom Fishing
1. Don’t try catch the bottom
Identify the opportunity, slowly buy into the position in small tranches. The best time to buy is as the stock is bouncing and has the best chance of a sustained upward movement.
2. Stay Disciplined
Ensure you don’t get over exposed, building a bigger losing position hoping it comes right. Make sure you stay on top of company news flow and developments that could see the share price recover or slowly drift lower. Shares at depressed prices have “depressed” investors looking to cut their losses and forget about their bad experience. Ensure you have a definitive exit strategy on the downside as well as the upside and stick to it.
3. Be Patient
Make sure you don’t jump ship without a valid reason, as you could be getting out before a turnaround materialises. But ensure you stick to your plan, why did you get into the position.
Bottom fishing is a way to significantly increase your portfolios performance, but without discipline and patience it can quickly destroy your portfolio. Some shares are cheap for a reason, so make sure you do your homework!
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