Everybody has heard the market saying, “don’t try to catch a falling knife,” right?
The concept being that if you don’t time the “catch” correctly, you might grab the blade by mistake and have a mess on your hands.
But what if you were able to try and catch that knife wearing a pair of heavy leather work gloves? You wouldn’t get sliced up so the worst thing that could happen is you just miss the catch. No harm, no foul.
The translation of this belabored analogy in trading is to have a rules and risked based methodology for the “knife catch.” Here are mine.
- You are looking for an extended and aggressive downtrend in the stock you are eyeing. Bonus points if perma-bulls in that stock are expressing their pain through social media.
- You want to see a large volume and price spike on a 5-minute chart. This indicates that the final bulls (in whatever time frame you are trading) have given in and “puked” up their shares. Note: You will know when this spike comes because the volume will be so large it will re-scale all the previous volume bars on your chart
- You want that 5-min bar (or the one following it) to end in a hammer; ideally green and at a support level.
Once those factors are in place you then use the hammer candle to define your risk/reward on the trade.
Take a look at this chart of intraday action on AAPL to illustrate what I am talking about.
You have to remember that this is a very specific setup and the technique works for a “trade only.” If the set up doesn’t happen, there’s no trade.
If the setup happens, you take it, and it fails, get out.
And if the setup happens, you take it, and it makes you money, take it and run.
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