The Falling Knife: A Risky Strategy for Buying the Dip
Introduction
The term "falling knife" refers to the attempt to purchase an asset immediately following a sharp decline in its price. In periods of panic and low liquidity, such an entry often results in significant losses.
1. Understanding the “Falling Knife” Concept
1.1 Definition and Metaphor
A "falling knife" is an allegory for buying assets during a rapid price drop. Just as one can easily get injured while trying to catch a falling knife, entering the market at the bottom without confirmation can lead to "injuries" to one's capital.
1.2 Motivations Behind Knife Catching
Traders hope to lower their average position or catch a rebound, but in 80% of cases, the price continues to decline, and losses escalate.
2. False Rebounds and Dead-Cat Bounces
2.1 The Mechanics of a Dead-Cat Bounce
A dead-cat bounce refers to a brief increase following a crash, often driven by short covering and stop orders.
2.2 Signs of a False Rebound
– A rebound occurs below the broken support level.
– Volume during recovery is below average.
– RSI and Stochastic indicators remain in the oversold zone.
2.3 Example of XYZ Stock
When XYZ stock dropped from 150 to 50 ₽, a rebound to 60 ₽ was accompanied by volume at 30% of the average and, without a retest of support, quickly turned into a −20% loss.
3. Technical Analysis
3.1 Support Levels and Retests
Key support levels define potential stops for declines. Only a retest and solidification above a level indicate a chance for reversal.
3.2 Volume Analysis
Spike Volume during declines and reduced volumes during increases suggest a lack of interest in buying.
3.3 Volatility and Indicators
ATR and VIX reveal the extremity of movements: higher values often correlate with more false rebounds.
4. Risk Management
4.1 Calculating Stop-Loss Using ATR
Use ATR × 1.5 to determine the stop-loss distance below support, reducing the chances of random stop-outs.
4.2 Trailing Stop
A trailing stop automatically follows the price, protecting a portion of profit during reversals.
4.3 Hedging with Options
Purchasing put options or using inverse ETFs fixes capital value in the event of further asset decline.
5. Trader Psychology
5.1 FOMO and the Fear of Missing Out on Profits
The fear of missing out drives traders to enter at the peak of a brief rebound without verifying analysis signals.
5.2 Greed and Perfectionism
The desire to quickly recover losses fuels aggressive entries, while the quest for the “perfect” moment leads to missed opportunities.
5.3 Methods for Controlling Emotions
– A trading journal detailing emotional states.
– The "timeout" method: a pause before making a position.
– A clear entry/exit scenario automated for consistency.
6. Fundamental Triggers
6.1 Corporate Reports
Weak earnings reports or negative news trigger declines and misguided rebounds based on support rumors.
6.2 Macroeconomics
Central bank decisions, sanctions, and geopolitical events heighten volatility and the risk of knife catching.
6.3 Example of UPQ
Following merger rumors, UPQ shares rose by 10%, only to fall by 30% when the deal didn't materialize.
7. Automation of Protection
7.1 Algorithmic Stop Orders
Scripts can set up trailing stops during Spike Volume, reducing the risk of human error.
7.2 Integration via API
API integration allows for the immediate placement of protective orders without delays.
7.3 Ready-Made Scripts
Pine Script and Sierra Chart indicators can detect retests and volume anomalies.
8. Real-World Case Studies
8.1 Biotech Crash (2020)
BiomedTech dropped from $120 to $30. Buying on a rebound at $35 resulted in a −40% loss within a day.
8.2 Oil Flash Crash (2020)
WTI fell below $0. Attempting to buy at $1 led to margin calls at −$37.
8.3 Crypto Dip (2022)
Bitcoin decreased from $45,000 to $20,000. A rebound at $25,000 resulted in a drop to $16,000.
9. Regional Characteristics
9.1 MOEX
Low free float and shallow order depth exacerbate false rebounds.
9.2 Example of Polyus
A gap from 21,500 to 24,000 ₽ occurred, but the rebound failed to hold, and the gap remained unfilled.
10. Averaging Strategies
10.1 DCA Dangers
Dollar Cost Averaging reduces the average entry price but increases overall losses during further declines.
10.2 Alternatives to DCA
Partial closing at the first rebound and hedging with options.
11. Case Study: Tesla Stock Trade (July 2025)
11.1 Situation and Entry
On July 10, following Tesla's report, shares fell from $650 to $580 in an hour due to margin reduction news. A trader opened a long position at $585, anticipating a rebound.
11.2 Signal Analysis
– The support level of $590 did not hold. – Spike Volume reached 350% of average volumes. – RSI dropped to 25, but without a retest of $590, the signal was invalid.
11.3 Position Management
A stop-loss was set at $570 (ATR $10 × 1.5). After a brief rise to $600, the price fell again to $550, triggering the stop-loss and limiting the loss to −2.6%.
11.4 Conclusions
A combination of retesting support, precise stop-loss based on ATR, and volume analysis helped avert significant losses when attempting to catch a “falling knife.”
12. FAQ
12.1 What is a falling knife?
It refers to purchasing an asset immediately following a sharp drop without confirmation of a reversal.
12.2 How to identify a false rebound?
Look for a retest of support, volumes during the rise, and confirmation from indicators.
12.3 When is it safe to enter?
Only after a retest of a broken support level and volume confirmation above average.
Conclusion
The “falling knife” strategy is perilous due to false rebounds and psychological traps. A comprehensive approach—technical analysis, strict stop-losses, hedging, automation, and emotional control—can help identify genuine reversals and preserve capital.
