Tuesday, September 16, 2008

Speculating on a Falling Knife

There has been a lot of turmoil these past few months with the collapse of Freddy Mac and Fannie Mae. Fannie Mae in particular used to be a well respected dividend stock that had a long history of dividend increases and I am sure makes up a large part of many portfolios in the United States and throughout the world. Now with these stocks, their portfolios are reduced substantially and I am willing to bet that many people may be thinking about perhaps buying more. There may also be many people who are considering initiating a position in either of the two companies. This investing phenomenom of buying a stock that has tanked in value is often refered to as catching a falling knife.

Catching a falling knife can go one of two ways. First, the stock can recover and as an investor you will look like a hero as your holdings increases in value substantially. Second, your stock can continue its downward slide and you lose more and more money. The trouble is that the risks of the first outcome occurring is not significantly great. I tend to look at it in terms of simple physics - things in motion tend to continue in motion and stocks are no different. For a stock to drop as drastically as Fannie and Freddy have, then there must be some serious problems with the company. Acting in times like this can only lead to more trouble.

If you want to invest in these types of stocks, my suggestion is to start watching these companies like a hawk to learn as much as possible about them. And then, buy only when there has been a significant turnaround in the stock price. Emotional impatience is the largest enemy to an investor . There is the urge to buy the stock on the way down to ensure that you catch the upturn when (if) it happens. Be patient and wait for a turnaround - this is not market timing, it is smart investing.


This article was written by The Dividend Guy. You may email questions or comments to me at info@thedividendguyblog.com.

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