Over the last year:
Amarin Corp jumped from $2.35 to $21.07
PaySign, Inc. spiked from a low of $2.41 to $16.77
Axsome Therapeutics has catapulted from $1.94 to as high as $28.00
Imagine getting in at the lows and riding those babies up…
…there is something heroic about being the person who bought a stock at its absolute lows…
With earnings season here, there will be plenty of traders dumpster-diving/catching a falling knife… trying to find the bottom on stocks that are getting sold off after corporate earnings releases.
For example, Netflix, which is down considerably (40 points in the pre-market after it announced its Q2 results last night)… is going to be a stock that some day traders will try to catch a bottom in…
It’s a risky strategy… but does offer high reward.
Is it worth it? And can you REALLY be able to pick bottoms in stocks?
My answer might shock you.
How often have you seen a stock drop and wanted to buy it?
Only when you bought it… a few hours or days later… the stock collapses and sells off even more… and you end up taking a massive loss.
It’s happened to me in my early days of trading.
However, over the years, I’ve realized just because a stock is dropping quick… it doesn’t mean you should buy it… and the stock being “down” too much isn’t a real reason to buy a stock.
That’s just trying to catch a falling knife… and it can get ugly.
Why try to buy a stock that’s falling rapidly with no signs of stopping, when there are indicators for finding when a stock has bottomed out?
No, they’re not hard to spot… and these indicators work because price action matters
when you’re trying to find reversal trades.
The Simplest Indicator to Spot Potential Bottoms
One of the easiest ways to spot when a stock has bottomed out is by looking at the chart. Basically, you’re looking for a support level. In other words, you’re looking for an area where the stock could have a tough time breaking below.
For example, check out the daily chart in Eros International (EROS).
The stock dropped significantly back in June after the company’s debt caught a severe downgrade from Moody’s, which shook traders… causing them to panic sell.
Now, if you were just trying to pick a bottom without looking at the charts… then you would’ve actually taken it on the chin even more.
So how do you know if a stock has stopped falling and is set to rebound?
Well, if you take a look at the chart, you’ll notice that whenever the stock locked in a positive day (white bars), there was no real volume behind it (we’ll get into the importance of volume shortly).
However, EROS was approaching right near a key support level of $1 (typically if a stock sells hard, there should be some buyers right around $1). That means it’ll have a tough time breaking below that.
If you notice, the stock actually has some support at the blue horizontal line (right around $1.25 / $1.30).
Now, just because there could be support there… it doesn’t mean we buy right away… we actually look at the volume as well.
Volume Matters When You’re Trying to Find the Bottom
Why does volume matter when you’re trying to find reversal trades?
If you don’t know, volume measures the number of shares that have been traded during a specified period.
Think about it like this… if you’re trying to find a bottom, you want to see a lot of demand for the stock.
What does that mean?
Well, you would want to see the stock bounce off the resistance level with volume.
Here’s what I’m talking about.
If you look under the price chart, you’ll notice the volume traded for that day. As you can see, EROS was actually bouncing off the support level with volume.
What that let us know was that there was heavy demand for the stock because 7.91M shares of EROS exchanged hands that day… and it only had an average daily trading volume of just 2.28M, according to Finviz.
That said, volume confirmed the bottom was in… and here’s what happened with the stock…
Is the Stock Breaking Above the Down Trend?
The overall trend in a stock matters a lot.
For example, if you think a stock could potentially bounce… you would wait for the stock to establish a support level… then move higher on above-average volume.
Now, if the stock breaks below the overall downtrend, that could be an indication that the bottom is in.
For example, take a look at the daily chart in U.S. Silica Holdings (SLCA) below.
Notice how the stock found some support right around $9.50. SLCA failed to break below that multiple times… and could’ve been a signal to keep an eye on the stock.
Not only that, you can see the stock breaking above the downtrend line.
Additionally, we see volume picking up with a move higher… as the stock traded ~1.74M shares, while its average daily trading volume was around 1.5M.
Here’s a look at what happened with the stock just over 2 weeks later…
As you can see, there are clear ways to figure out when the bottom is in.
That said, the next time you’re looking for a stock to bounce… don’t try to catch the falling knife. Rather, look for an area of support, volume confirming a move higher, and/or a break above the downtrend.
I get it, it’s daunting at first with all the noise in the market. If you’re struggling to find ways to pull high returns from the market… then click here to watch my latest training lesson in which I go over how you can find clarity amongst the chaos in the markets.