Bottom Fishing

Bottom fishing is one of my favourite sports, but it’s not for everyone because you may be just as likely to hook yourself an old tyre or rusty bicycle as you are to land the prize fish lurking at the bottom of the pond.

Bottom fishing means looking for a bombed-out share that is priced at an all-time low and which you believe will subsequently recover. Because this is such a dangerous sport, I suggest the following:

• Try to identify stocks that have fallen massively today as well as over the long term. An immediate rebound will help you in your resolve to hold the stock for the long term potential, and will allow you to secure (with a stop order) or bank (by part-selling) some profit in the short term.
• Use an initial position size that you are willing (if not exactly “happy”) to lose entirely; such as £1-per-point on a 50p-per-share stock, rather than £10-per-point on a 1000p-per-share stock. You can always “average down” (carefully) or “pyramid up” your position when you see which way it goes.

How to Discover Bottom Fishing Opportunities

Once way of identifying bottom fishing opportunities is to open the ‚Yahoo! Finance Price Losers (%)‛ list in your web browser via this web address:

http://uk.finance.yahoo.com/losers?e=ftas

It will show you which stocks have fallen furthest today, and you can then click the chart link to see how the price fall fits into the context of a longer time perspective.

Another way to find bottom fishing opportunities is to watch the news. Big price falls are usually newsworthy and will make the headlines on the BBC News web site, on investment web sites such as The Motley Fool, and (of course) on your chosen spread betting company’s own news feeds.

Bottom Fishing Example – “French Correction”

On the morning of 17 May 2012, French Connection (or should it be “French Correction”?) shares suffered a “correction” of some 25% when they fell from about 40p-per-share to about 30p-per-share. The following chart from Yahoo! Finance shows the longer-term price action, and “X” marks the spot at which the shares were priced on this particular morning.

From a bottom fishing spread bettor’s point of view, this stock may have been attractive at this point for a number of reasons:

• The sudden gap-down of 25% could lead to an immediate bounce-back profit for the day trader when the market realises that the correction has been overdone.
• Judging from what traders and investors thought the shares to be worth only a year earlier, the price potential may be attractive to a longer-term position trader.
• From a technical perspective, the price appears to have fallen to a support price – indicated by the dotted line – that has held on two previous occasions, making a rebound or recovery more likely… but by no means certain.
• From a “news” perspective, the latest price drop resulted from a third profit warning. Apparently, profit warnings always come in threes.
• From a personal perspective, a previous long bet that I had placed on French Connection had “stopped out” some weeks earlier at about 45p-per-share. So I would now be able to buy back, at a 33% discount, something that I had previously sold at a higher price thereby notionally “selling high and buying low” without having gone short.

There may also have been perfectly valid reasons for not taking the trade, such as the fact that any stock which falls 25% in a day can easily fall another 25% within a day; and any stock that has lost 80% of its value within a year can easily lose another 80%.

All things considered, the spread bettor would be wise in this case (as ever) to deploy a modest position size initially until he sees which way the price will go. Alternatively, he might apply a relatively tight stop order (ideally guaranteed) to a larger day trade position size.

How to Catch a Falling Knife

Many people advise against – or shy away from – bottom fishing, for fear of trying to catch a falling knife. Many spread bettors and other traders lose digits (not fingers, but trailing zeros from their bank balances) when they attempt this feat of daring, but I think it’s because they’re doing it all wrong because they:

• Try to grab too soon, when the knife has only just started falling.
• Grab too hard by making a big initial investment.
• Grab too doggedly, with no intention of letting go.

My suggestions for trying to catch a falling knife are:

• Try to catch a knife that has fallen rather than one which is still falling. Has the price of this financial instrument fallen a long way, and does it look like it’s bounced off the floor?
• Grab cautiously at first using the light grip of a small position size. Your fingers may still get cut, but the lacerations won’t be too deep.
• If the price keeps falling, let go, possibly automatically using a stop order that you placed just below what you thought was the floor level. Subsequently you can try to grab again with your other hand.
• Once you’ve got a firm grip, tighten it by increasing your position size as you lift the fallen knife from the ground.

Top Fishing

It’s only logical that whereas long traders might engage in a spot of bottom fishing, short traders might try their hands at “top fishing”. If you thought that Apple shares or the price of Gold (for example) had inflated to bubble-like proportions, or that Facebook shares had been massively overpriced at the time of flotation, you could just as easily go short in a spread betting account by selling as you could go long by buying.

Top Fishing Terrors

While in one sense top fishing is the exact mirror image of bottom fishing, it is in several senses more dangerous and terrifying because:

Any financial instrument that has apparently “topped out” will be priced much higher than one that has apparently bottomed out. A topped-out stock at 1000p-per-share is obviously much more likely to move 100 points against you than a bottomed out stock at 10p-per-share.

While the price of any financial instrument can only fall as far as zero, thereby limiting your maximum loss absolutely, theoretically the price of a financial instrument can go on rising forever “to infinity, and beyond” before the force of financial gravity inevitably brings it crashing back to earth.

As a result, top fishing arguably requires you to pay even more attention to risk management through prudent position sizing and the effective use of stop orders.