Should You “Catch the Knife” as Big Tech Falls? By Michael Salvatore, Editor, TradeSmith Daily In This Digest: - Buying short-term stock crashes is complicated…
- What to do if a tech stock drops 20% in a week…
- Why claims of “bear territory” for NVDA are nonsense…
- Where Jason sees the Big Money flowing today…
- A warning signal that Quantum Edge spotted in advance…
Everyone loves to try catching falling knives… When stocks are in steep downtrends, it’s all too tempting to try to buy the bottom at just the right moment. Sure, the old cliché on Wall Street warns us not to try and “catch a falling knife.” But act quick enough and you grab the handle, safe from any harm and the proud owner of a great stock at a good price. Misjudge the trajectory, though, and you get a fistful of jagged blade for your trouble. I remarked on Wednesday how some casual investors like to buy stocks when they make big, short-term down moves. From what I can tell, they like to do this much more than they like to buy stocks flying higher – because those stocks just look like a missed opportunity that’s now overpriced. We proved the opposite is true. Buying stocks that are vastly outperforming the market is a great idea… even if they’ve doubled in the span of six months. Going forward from performance like that, three-month returns have been both strong (average gains, counting wins and losses, of 11.7%) and show a decent probability of working (positive 61% of the time). But what about those falling knives? Is there something to buying a certain class of volatile stocks after they fall by some extreme amount in a short period? Right now is exactly the time to be asking this question, with volatility rocking some of the former biggest winners this week – like Nvidia (NVDA); keep reading for our take on that, specifically. As with any fascinating idea that springs to mind here at TradeSmith, we put it to the test… Here’s what you should do if a tech stock drops 20% in a week… We went back and looked at all the Nasdaq 100 stocks going back 10 years. We wanted to know what happens if you bought one after falling 20% or more in the span of just five trading days. A stock with that much of a haircut is going to get some eyeballs and inspire some itchy trigger fingers. And here’s what we find from a probability standpoint: - Buying a five-day, 20% drawdown and holding for three months has given a win rate of 49.9%, on average – slightly worse than a coin-flip.
- But in exchange, you’d have gotten an average trade result (counting wins and losses) of 13.9%. That’s a huge return, especially considering more than half of the trades are losers.
- The average winning trade was even more impressive, at 21.8%.
- And the average loss, while uncomfortably common, was just 4.8%.
So, when we compare to Wednesday’s study on the “winners keep winning” thesis, this isn’t necessarily a better idea. The odds are much more on the side of buying red-hot winners. But if you happen to catch a knife in the tech sector, history suggests you’d be well rewarded for it. NVDA is down, not out, and not in a “bear market”… NVDA made the headlines this week – an evergreen sentence if I’ve ever written one. This time, it was for entering what pundits like to call “bear territory”: 20% or lower from the high. But this 20% is somewhat arbitrary. We use it to measure bear markets in the indices. But for individual stocks? It’s just a different story. Stocks don’t act like indices, and vice versa. So, if we want to be intelligent about this, we need to look deeper and take NVDA’s footprint into account. We do that at TradeSmith with what we call the Green, Yellow, and Red Zones. These zones are algorithmically determined by a stock’s individual risk profile. So, we don’t necessarily consider a 20% down move in any stock “bear territory.” In fact, it might even be a buying opportunity. With that in mind, I’ll ask you to take a look at this chart of NVDA, where I’ve also marked its current Yellow and Red Zone levels based on our TradeSmith Volatility Quotient (VQ%) on the stock. Yes, NVDA’s price action isn’t looking so hot here. It’s down precisely -21.3% from the all-time high it set in June. But that’s not quite enough to even put it into caution territory. That would be down at $101.16. And we wouldn’t tell you to sell NVDA until it crosses below $78.21: 
Why accept so much more potential downside? It all comes down to volatility. NVDA is High Risk in TradeSmith, with a VQ% of 43.87%. This is the number we assign to stocks that accounts for their past movement to give you an expectation of the maximum normal drawdown before a sell signal flashes. NVDA is a volatile stock… and so we shouldn’t bow out as soon as we see a 20% drawdown. Really, we should treat any price north of the Yellow Zone as a buying opportunity. Remember, the mainstream financial media thrives on negativity and fear. They’re going to blast you you the worst possible interpretation of the most widely owned stock of the moment to get you to tune in. Don’t fall for it. NVDA may have more downside to come. We aren’t saying it won’t. We’re just saying we wouldn’t advise following some arbitrary 20% number because these media reports made you feel like it’s important. Jeff Clark says it’s time to “put down the ice cream”… If you’ve spent any length of time reading financial newsletters like ours, odds are good you’ve run into the name Jeff Clark. Jeff’s a master technical analyst and options trader. He’s also one of few analysts who were warning their readers about the calamitous bear market to come in 2007 well before it happened. I worked with Jeff at the start of my own newsletter career, and I cannot tell you how much I learned from watching him trade… and, just as importantly, from watching him write and publish high-quality research for his subscribers. Anyway, I’m bringing up Jeff because, for the first time in a long time, he’s sounding the alarm bells once again. He, like me, thinks the accommodative actions of the Fed don’t jive with the economic data or the stock-market price action. And he’s warning traders to stay cautious. Click the thumbnail below to watch his warning – along with some salient words about the financial publishing business and how it all relates: 
While you’re there, I highly recommend signing up for his Market Minute newsletter. Not only because it’s kind of my baby – one of my first-ever projects as a fresh-faced editor in our industry – but because it’s absolutely packed with short-term technical trading ideas and valuable broad analysis like this one. When you go here to watch that video, look for the JOIN NOW box on the right side of Jeff’s website to sign up for Market Minute. Jason’s Quantum Edge hotlist gives us a fresh peek at the Big Money moves… TradeSmith is genuinely a quantitative trader’s dream job. Every day, my inbox is bombarded with unique reports of highly specific, tradable signals on overbought and oversold conditions, rare divergences, quality stocks breaking out, ETFs at overextended extremes, and much more. Longer-term investors eat good, too, because of the hotlist Jason Bodner provides in Quantum Edge Pro. The essence is simple: It’s the 10 stocks ranking highest on Jason’s Quantum Score – a proprietary, composite measure of a stock’s technical momentum, driven by the likely presence of institutional capital, as well as fundamental quality – plus the five lowest. It’s like looking behind the shoulder of a billion-dollar money manager and seeing where they’re bidding each week. It’s always full of surprises and interesting ideas for stocks to buy… and just as interesting names to avoid. With Jason’s permission, I share the list here every so often so you can see what I mean. Here’s the most recent list: 
The green side of the hotlist is full of consistent Big Money targets. We’ve been seeing Check Point Software (CHKP), Monday.com (MNDY), MakeMyTrip (MMYT), Tradeweb (TW) and Halozyme (HALO) appear time and again in the top brass. This week we’re also treated to Nu Holdings (MU), a Warren Buffett favorite. We’re also seeing two names in the insurance space, ever a great business, in W.R. Berkley (WRB) and Brown & Brown (BRO). As for the worst-ranked stocks at the bottom, what sticks out to me is Dollar Tree (DLTR). Its competitor Dollar General (DG) just had an absolute disaster of an earnings report last Monday, Aug. 29, where it slashed its profit guidance and reported big misses on income and earnings per share. DLTR took it on the chin as well, as what’s bad for one low-cost-good store is likely bad for all of them. But this Wednesday morning, Dollar Tree’s earnings confirmed it. It was a mirror image of DG’s, with big misses on revenue and earnings, along with poor forward guidance. This just shows us how valuable Jason’s hotlist is. You could’ve used it earlier this week to get a warning sign in DLTR, then either get out of the stock before its 22% post-earnings slide… or target it with short trades. Jason’s subscribers get access to the freshest list every single week as well as a model portfolio that’s beat the broad market 7 to 1. To learn how you can become one of them, and also learn more about his strategy that targets high-quality growth names backed by institutional capital, click here. To your health and wealth,  Michael Salvatore
Editor, TradeSmith | 
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