The first thing most people learn about the stock market is the trite old saying 'buy low, sell high'. There is no doubt that this is a profitable approach to the market and there are multiple considerations to consider when you are 'fishing'.
The first thing to consider is that many trend followers and momentum buyers believe that bottom fishing is a suboptimal approach. One of their primary arguments is that when you are buying a stock that is near its lows, that means that nearly everyone holding shares has a loss.
One of the basic tenants of technical analysis is that traders and investors have a tendency to sell to breakeven when they have been holding a stock with a loss for a while. They are just relieved to have their money back. They want to forget the unpleasant experience and then move on.
Overhead resistance will impact the way a stock trades but it is something that we can anticipate if we implement this style. Overhead resistance isn't often as rigid as many technicians like to believe it is.
Here are some other key considerations to use in developing a bottom fishing approach
- The important thing isn't buying at the absolute low but buying when there is the best chance for sustained upside. It is understandable that highly competitive traders are always trying to buy at the exact low but, quite often, that will not be the best time to buy from a strategic standpoint. It is more important to buy when there is the best chance of sustained movement. That may be due to a news event or a technical development like a higher high. Sometimes a new all-time low can trigger a quick bounce as traders conclude the selling is 'overdone' but catching a bounce for a flip is a different matter than bottom fishing for bigger returns.
- When bottom fishing stocks it is important to remember how the cockroach theory applies to stock. If you see one problem, then there usually are a dozen more hiding some place. Bad stocks often trade at their lows for good reason. Just because a stock is at the lows doesn't mean it can't go lower, especially when other issues, under the surface, start to bubble up.
- The biggest challenge of a bottom fishing approach is that it tends to require much more patience than momentum buying or position trading. Stocks at their lows have most likely been drifting for a while and are weak due to disinterest. There is no way to know when interest will return but it can be a very long time. Take a look at the MLP sector as a good example of a sector that appeals to bottom fishers right now. The folks buying stocks like Boardwalk Pipeline (BWP) or Energy Transfer Partners (ETP) have time frames of months or years and not days. If you aren't mentally prepared to stay with these trades for a long time you shouldn't take them to begin with.
- Bottom fishing tends to lead to undisciplined trading. Bottom fishers need to make an extra effort to stay disciplined. When you hold a stock for months and it does nothing but drift around it is very easy to grow bored with it and cut it just to be doing something. On the other hand, it is also quite easy to ignore the movement in these stocks which may seem random. It is very easy to find yourself sitting in something that is dripping lower on little volume. Those losses can add up fast if you don't have a firm stop in place. The stock you bought at the 'low' $2 higher can produce a sizable loss if you aren't using basic money management.
- There are two key types of bottom fish plays. There is the overreaction play and then there is the 'value play'. The recent action in Action Alerts PLUS holding Facebook (FB) is a good example of both. When the news of the privacy issues first hit, there were plenty of traders anxious to jump in for a quick recovery. Their view was that the market overreacted and the stock would bounce fast. That analysis proved faulty but now the longer term bottom fishers are inching in on a similar argument. Maybe the privacy issue is a big deal but over time it will be dealt with and forgotten.
- Bottom fishing on earnings, news events or secondaries can offer good opportunity to trade some volatility but it requires a very aggressive approach to play the big swings. It is very easy to let these short term trades turn into 'investments' so make sure you have a firm plan in mind before you enter.
This market is offering some bottom fishing opportunities but consider your approach and your strategy before you jump in. Cheap stocks have a nasty habit of becoming cheaper.