Whenever there is a sustained down period in the market, one of the
first things you are likely to hear investors talk about is bottom
fishing. In bear markets or in general, when the market has gone down
for a period of time, certain stocks will be taken down to a lower level
than they deserve to go.
A lot of investors enjoy the challenge of bottom fishing. A lot of
them also wrongly assume bottom fishing and picking market bottoms are
the same thing. The main reason they are not the same thing has to do
with the fact that you are not trying to call the end of a market down
turn.
Bottom fishing is, in essence, buying stocks that are on sale. On the
other hand, picking market tops or bottoms deals with prediction, and
that is a complicated and impossible feat to achieve successfully on a
regular basis.
An investor can employ many strategies when it comes to bottom
fishing. The following paragraphs describe some of the most popular that
many investors and professionals use to identify the right stocks. Keep
in mind that there is not going to be any one solution to picking the
right bottomed-out stock.
A blend of strategies can make the selection process easier.
Technical Analysis and Bottom Fishing
Technical analysis is the use of charts, as well as stock price, to
help determine the correct stock to buy. Technical tools make it easier
to spot an oversold stock. This oversold stock may indeed be the perfect
candidate.
Using technical analysis means that you don't have to worry about the fundamentals of the company. Your concern is price action.
Technicians have many tools and different charts they can use to help
identify a stock ready to make a rebound. But, although technical
analysis is a very powerful tool, it is also time consuming to learn.
Learning to identify chart patterns can be a difficult endeavor. You
must also become fluent in the use of indicators that help you gauge
market activity. Learning all of this takes time and patience.
Fundamental Analysis and Bottom Fishing
If being a technician is not your thing, maybe you would prefer
looking at the stock a little more deeply than just its price alone.
Fundamental analysis, also known as value investing, is the
philosophy of studying a company's balance sheet, as well as
understanding its business, to pick a stock that is undervalued. The
biggest advantage to fundamental analysis comes in the form of
identifying stocks that have been ignored by other traders. Remember:
You are searching for value.
In this case, value comes in the form of price per share -- the
current price per share versus what you think the price per share should
be. Because you are a fundamentalist, this price per share has you
buying stocks that are on discount with the hope that the market will
move the stock to your target price.
Learning to read a company's balance sheet is a difficult and slow
process. And, finding an undervalued stock is still no guarantee that
the stock price will move to meet what the perceived price should be.
The 52-Week Low and Bottom Fishing
You have all heard about the 52-week low. Well, one of the ways to
find potentially bottomed-out stocks is by searching for stocks that
have dropped over a certain period or dropped by a certain percentage.
You could easily do a search for a stock that has fallen 70 percent or
more in value within the last 18 months or so. You could look for stocks
that have made new one-year lows, for example.
Buying the Beaten Big Caps
This strategy is simple. You are buying the biggest market-cap stocks
that have taken a down turn -- the best of the big-name stocks. Every
market has them. The ideology holds that these bigger-capped stocks will
still have viable businesses that are just out of favor. Or, they may
have missed a couple of quarters in their earning revenues.
Sometimes, there can be an internal management issue that has little
or nothing to do with the business. Any one of these factors can lower a
stock's price quickly. No matter the market or how big the company, at
one time or another, that stock can be on sale. Once the sale has
occurred, the bottom fisher needs to decide if the downward move is
justified or an overreaction to something else.
Another benefit to buying these beaten-down big-cap stocks is their
yield. Many times, these companies pay a dividend. If the dividend has
not been cut, you are now able to buy a higher-yielding stock for a
lower price. These are rare, and when they are a worthy investment
opportunity, you need to act quickly.
A Word of Caution about Bottomed-Out Stocks
Technical and fundamental analysis, as well as looking for 52-week
lows and buying beaten big caps, can all be excellent ways to look for
potentially bottomed-out stocks. These discounted prices mean you can
purchase a bigger stake. So, any upward move in the price is quickly
rewarded. Usually, this will mean that you are buying companies in
sectors that are essential or that you believe will make a comeback in
the near future.
Keep in mind that there is often a reason why certain companies have
lost 70 percent or more of their value in a short time. Those same
factors do not change overnight. You need to invest cautiously.
You should keep in mind that a lower stock price can be an indication
of future trouble. So, be cautious and decide to purchase only after
you have done your research. You should also realize that there is no
guarantee that a company will be able to rebound this time. If there are
underlying problems, this could only be the beginning, and the price
may head lower in the future.
The most important factor in successful bottom fishing is market
timing. I said at the beginning of this article that market timing was
impossible to do consistently, and that is what makes bottom fishing so
difficult. You do not know if the price you are paying is at the lowest
it can go or if it will go lower.
Investors looking to bottom fish need to be prepared for the
potential of buying the stock of a company that may not exist in the
near future. So, although the up side is high and, with time and
patience, you will be rewarded for the good picks, you want to limit
your bad picks because those can be quite costly.
There is no exact way to know which of the stocks you bought will be
winners in the future. Keep in mind that bottom fishing can be rewarding
as long as you are prepared for the potential pitfalls.
http://www.esignallearning.com/education/marketmaster/archive/2011/archive_index.aspx?date=072211
