A Trader's Guide to Stock Trading: Avoiding "Catching a Falling Knife"—A Bottom-Fishing Strategy Integrating Fundamentals, Technicals, and Sentiment

This article outlines a comprehensive, multi-faceted strategy for "bottom-fishing" in stock trading—buying stocks at or near their lowest price—to avoid the risky practice of "catching a falling knife." The framework integrates preliminary analysis, fundamental research, technical analysis, and sentiment analysis to identify and execute high-probability opportunities.

Preliminary Analysis & Catalyst Tracking: Begin by monitoring a declining stock to understand the reason for the drop. Determine if the issue is company-specific, industry-wide, temporary, or fundamental. Proceed only if the initial investment thesis remains intact.
Fundamental Due Diligence: Conduct thorough research using the "4M framework": assess the company's Business Model, competitive Moat, quality of Management, and the Margin of Safety provided by the current price. Review financial statements and use conservative valuation models (like DCF) to establish intrinsic value.
Technical Analysis for Timing: Patience is critical. Avoid buying too early and wait for selling pressure to weaken. The article suggests several technical entry methods, illustrated with chart examples:
- Buying on the "right side" of a V-shaped reversal after the price rebounds to a predetermined level.
- Waiting for a bullish crossover, such as the 5-day EMA moving above the 20-day EMA.
- Purchasing after a stock stabilizes and forms a bottom (e.g., at least 5% above its 52-week low).
- Trading a high-risk "waterfall-like drop" by combining delayed entry with buying during the subsequent recovery phase.
Sentiment Analysis: Gauge market psychology to find contrarian entry points. Look for extreme pessimism, such as widespread negative price targets or the capitulation of early buyers. Other signals include analysts downgrading expectations and using social media to test for overwhelmingly bearish sentiment, which can indicate a potential turning point.

The strategy emphasizes combining these elements to make informed decisions, rather than relying on a single approach, and advises integrating it with other investment philosophies for a holistic market understanding.

Author: SixSigmaCapital

Compiled by: Yuliya, PANews

This article aims to summarize a process for buying at the bottom of stock prices, elaborates on lessons learned in practice, and establishes a framework for sustainable identification and execution. Investors are advised to combine this strategy with other investment philosophies for a more comprehensive understanding of the market.

Preliminary Analysis and Catalyst Tracking

When a stock that an investor is interested in starts to decline, it should be closely monitored. Identify any impending catalysts, whether positive or negative. The absence of a clear catalyst usually means that investors have more time to analyze the situation.

At this point, the key is to figure out the reason for the stock price decline: Is it a problem specific to the company or a common predicament in the industry? Is the stock price decline reasonable, or is it being over-punished by the market? Is this a temporary problem, or a fundamental problem that will completely change the original investment logic? If the reason for the decline has not broken the initial investment logic, then we can move on to the next steps and conduct a more in-depth consideration of this investment opportunity.

Fundamental due diligence

It is essential to complete the fundamental research as early as possible. The classic "4M framework" is an effective tool, which includes four dimensions:

Business Model (Meaning): What specific business the company does.
Moat: What competitive advantages does the company possess?
Management: The competence and character of the management team.
Margin of Safety: Does the current stock price provide a sufficient margin of safety?

Investors are advised to carefully review the company's financial statements and familiarize themselves with its three main financial statements (income statement, balance sheet, and cash flow statement). They should also pay attention to earnings call conference calls. If using a DCF (discounted cash flow) model for valuation, it is essential to use a conservative estimate to determine the stock's intrinsic value. This ensures that when the time is right, investors will clearly know they are buying at a significant discount.

Combining technical analysis

Don't try to buy the dip too early; patience is key. Ideally, investors should aim to be among the last to buy. This is crucial because it gives you time to analyze previous price action and wait for selling pressure to gradually weaken. Studying charts across multiple timeframes is recommended; daily and weekly charts are excellent starting points.

Here are some technical analysis methods that can be used individually or in combination:

Buy on the right side of the "V-shaped reversal"
Waiting for the 5-day EMA (Exponential Moving Average) to cross above the 20-day EMA.
Buy at long-established support levels
Wait for the stock price to form a bottom at least 5% above the 52-week low before making a tentative purchase.
Buy during a "waterfall-like drop" (this method carries a high risk).

The following examples illustrate the application of these methods.

1. Buy on the "right side" of a V-shaped reversal.

This is a relatively simple strategy: first, determine an ideal price you're willing to pay, then patiently wait for the stock to stop falling. When the price rebounds to that level, you can execute the trade. This is a more probable entry method and allows you to set a stop-loss at a recent low to protect your position.

2. Exponential moving average crossover

Waiting for the 5-period EMA to cross above the 20-period EMA is a simple strategy. Its core idea is to wait for a potential trend reversal confirmation signal before investing any funds.

Take the recent FLY trade as an example. The stock initially attracted investor attention, but investors waited for the 5-day EMA to cross above and stabilize above the 20-day EMA before entering the market when the price retraced to the 20-day EMA. This trade ultimately proved successful, yielding a return of 35% to 36% within approximately six trading days.

3. Bottoming out

Another recommended strategy is to wait for the stock to stabilize above its 52-week low and begin forming a bottom (e.g., at least 5% above the low). The reason is simple: investors need to see evidence that the stock price is likely to hold the previous low and that a trend reversal may be underway.

Looking back at 2023, BABA serves as a prime example. Despite the stock bottoming out at $55 per share the previous year, some investors chose to enter in December 2023 when the price was between $68 and $70. At that time, the stock was bottoming out, and there was a significant mismatch between its price and value, with a P/E ratio of only 7. Later, when the price retraced to the 40-week SMA (Simple Moving Average), these investors added to their positions and still hold those shares today.

4. Waterfall-like drop

UNH is an example of trading a "waterfall-like drop." This is a high-risk setup, but the risk can be managed by combining the principles of "delayed buying" (waiting for sellers to reduce their positions) and adding to positions on the right side of a "V-shaped reversal."

When UNH's stock price first dipped in mid-May, it entered investors' watchlists, but they didn't immediately buy. The massive selling volume at the time was enough to deter most. However, after completing a fundamental analysis, from a valuation perspective, $240 was marked as a worthwhile buying level to consider. The buying began when the stock price started to decline rapidly in August. As the price began to recover, purchases were made in batches within the $230-$240 range. Finally, the position was closed out after the gap was filled in mid-October.

Another example of buying during a waterfall-like drop is successfully capturing the bottom on April 7, 2025. In-depth analysis was conducted over the entire weekend before executing the trade at 4 AM (Eastern Time) on that Monday.

Sentiment Analysis

Tracking market sentiment is another important piece of the decision-making puzzle. While it's not an exact science, there are several specific methods that can be incorporated into the analytical process.

As mentioned earlier, it's not advisable to buy when the general public is bottom-fishing. Instead, look for entry points when early buyers have become frustrated and eventually given up. A key signal is when extremely pessimistic target prices begin to circulate in the market, or when investors who were "all in" on a single stock sell their positions out of desperation. Typical examples include Tesla's stock price crash in April 2024 when it fell to $150, and the widespread belief at the time that Google was "doomed to fail" in the field of artificial intelligence.

In addition, waiting for analysts to lower their expectations and target prices is also an effective strategy. This process usually reduces risk; once market expectations are lowered, a company only needs to achieve a small improvement over expectations to potentially generate a positive stock price reaction.

Finally, if you have a following on social media, you can use them to gauge current market sentiment. For example, you can post a message on social media to test market sentiment, such as asking, "I bought UNH at $237, did I lose a lot of money?" If the post gets unusually high engagement, and the vast majority of replies are bearish, with some even predicting a price below $100, this extreme pessimism can be considered a good contrarian indicator.