There are two basic technical approaches to the stock market. The first is to buy high and look to sell higher by buying breakouts and riding momentum. The second is to try to buy low and sell high by focusing on stocks that are good values and are mispriced by the stock market.
When the market is in a strong uptrend, the buy high and sell higher approach works very well. Riding momentum when market conditions are good is usually the road to substantial gains
However, when the market has been struggling for a while and stocks have been badly beaten up, then there can be some great opportunities in bottom fishing. If not done right, bottom fishing can be very costly and will wipe out traders that are not careful. More market players suffer major losses from bottom fishing than anything else.
Bottom Fishing Mistakes
The biggest mistake that investors make with bottom fishing is that try too hard to predict the absolute lows. They are convinced that the stock that they like is an exceptional value that is being mispriced by the market, and if they don't hurry and buy into the teeth of a decline, then they will miss out on the opportunity of a lifetime.
It is understandable logic, but stocks are not like consumer goods. A drop in price does not necessarily make a stock a great opportunity. It may indicate that there are some substantial problems that are not readily apparent.
The problem for market players is that we can never be sure that a stock is dropping because of market conditions and mispricing of fundamentals or whether it is dropping because the business is deteriorating, the economy is poor, or any number of other legitimate reasons.
The key to effective bottom fishing is to actively avoid trying to buy the absolute low. The only way to buy the exact low is to buy into the teeth of a decline and then hope that there is an immediate reversal. It is possible to catch an oversold bounce when there has been panic and a sharp drop, but those are often very short-term trades.
If the goal is to build a position trade that may last months, then the goal should be to buy only after a low has formed and there is a bounce. The benefit of this is that the recent low becomes a very obvious support level. If the stock rolls over again, then you have a defined level of risk. You can exit and then wait for conditions to develop and try again.
Trying to Catch a Bottom in the ARKK ETF
Let's take a look at something that has been in an ugly downtrend for quite a while. I'm not suggesting that ARK Innovation ETF (ARKK) is a good buy, but there have been many traders trying to time a low in growth stocks in general, which is the main holding of ARKK.
If you have been trying to catch a bottom in this ETF, the safest methodology is to buy on positive action and then set a stop close to that level. If you have done some quick flipping, you would actually come out ahead despite the fact that the stock is still downtrending, hitting new lows, and stopping you out. If you are interested in trying to catch a bottom again, then wait for strength and set a stop close to that recent low. The exact levels will depend on your strategy, but if you have bought into the teeth of weakness, you have a much greater chance of a losing trade.
The current market action is creating some exceptional bottom fishing opportunities, but there is no way to know how long the current selling pressure will continue. If you want to try to buy some bargains, then stay patient, wait for strength, and then set tight stops. If it doesn't work, then keep trying until it does. Eventually, market conditions will change, or you will be forced to recognize that you picked the wrong stock.
