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Should You Try And Grab This Falling Knife?

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There is an old traders’ cliché that says that it is dangerous to attempt to catch a falling knife. Like most clichés there is an element of truth to that, but I can assure you that thousands of traders in thousands of dealing rooms around the world do that, or more accurately what looks like that, every day. They know that markets tend to overshoot and that there is good money to be made trading retracements, but they have rules for entry that increase their chances of finding the low and decrease their risk.

The most common of those is to wait until the knife, while it looks to be still falling, is actually bouncing around on the floor. That means waiting until whatever you are trading has shown signs of forming a bottom. With that in mind, take a look at the chart below for Petrobras (PBR).

(Click to enlarge)

I know it looks ugly at first glance but take a closer look at the last few candles. What you see there is a potential bottom forming, setting up the kind of trade I mentioned. The low of this move was reached on June 1st at $9.20, a level that was attempted again six days later, once again without breaking through. The low on that occasion was $9.22 and while that two cents may not seem important there are major implications to even a very slightly higher low on the second try at a level.

When traders see a major support forming it is often based on big commercial or fund orders at the level. Those that are…

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