Falling Knife

What is a Falling Knife?

The phenomenon of a falling knife is as tricky as it might sound. Like, you cannot catch a falling knife without getting hurt; you cannot catch a tradeable asset in a strong downtrend without facing a financial loss. The resemblance of this special downtrend pattern is created with the event of a literal falling knife that is full of dangers and horrors; since a falling knife can be challenging to deal with, provided that it has the potential and higher probability of hurting you, it is often recommended to let it fall first.

However, some of us like to live a fearless life and tend to attempt catching falling knives when they're airborne. While, in some cases, people might get lucky getting out of this situation unscathed, most daredevils are met with an injury that is always on the cards.

Keeping this analogy in mind, professional traders often respect this pattern knowing the gravity of its impact. Moreover, they tend to utilize it to their benefit by studying the crucial points of the asset price drop to know where the knife has stopped its descent and is ready to bounce back.

Difference Between a Falling Knife and a Spike

To a beginner trader, a falling knife and a spike might seem like two sides of the same coin. However, they have got an important fundamental difference. In the case of a spike, the price shoots in an upward or downward direction due to an unexpected event.

On the contrary, a falling knife is a long-term price action that plays out due to faulty fundamentals.

How to Catch a Falling Knife?

As absurd as it might sound, catching a falling knife can be tricky and full of unprecedented dangers. However, most experienced traders survive by following these practices:

Monitor Structural Issues

The monitoring of structural issues in an asset holds key importance. For instance, the recent price dump of Bitcoin to a whopping log of $17,622 came due to the bearish macroeconomic events that involve the rise in inflation and interest rates. However, Bitcoin quickly bottomed the sell-off and is now trading at $23,000. So, catching the falling knife would have been brilliant in this situation.

Try to Clear Out the Audience Exaggeration

Retail traders are always worried about the shorter time frame. This leads to them being washed out when the macro trend in a larger time frame follows through. For this reason, as a trader, you need to clear any biases from the surroundings and exploit the exaggerated price actions, if you get any.

Reduce Your Scope of Time Frame

Ensure that you start from a larger time frame to understand the macro sentiments and narrow your search to the shortest available time to accurately read a trade setup's internal and external price actions.