Market Wrap-up for Jan. 7: When Bargain Buying Goes Wrong

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Bargain buying can be an effective strategy for getting into a stock  at a relatively cheap price, netting you a handsome return. It is a strategy that we have talked about many times at Dividend.com and one that we always suggest investors should look deeper into. But bargain buying does not always go as planned, as larger trends or issues can sink a security even further.

Don’t Catch a Falling Knife

If you bought into a broad market fund in early 2009, when many were saying we were heading for a full-blown depression, you made the ultimate bargain buy. Since then, stocks have rallied well over 100%, making it quite an effective bargain purchase. However, a more recent example of bargain buying can display the dangers associated with the strategy.

The phrase “don’t catch a falling knife” refers to an individual trying to time the bottom in a certain stock or asset. If it is mistimed, the security can continue to plummet, hence the “falling knife” portion of the phrase. A recent example comes from oil stocks. Below is a six-month chart of oil juggernaut ExxonMobil (XOM):

XOM

At a number of points in September and October, it appeared as though the stock had bottomed and many figured that oil’s rout had to be nearing an end. But oil continued to plummet, as it just fell below $50/barrel this week for the first time in five years. That plummet brought XOM with it, punishing anyone who tried to pick a bottom in those months. Although it appears the stock hit a more comfortable bottom in mid-December, it remains to be seen if that truly is a bottom.

Tips for Bargain Buying

Sometimes all the research and due diligence in the world can still lead to a failed bargain buy, and that is OK. In many cases, however, your research and hard work will keep you from making a mistake like buying a stock too early. In this particular case, XOM was at the mercy of crude oil and its wild volatility, which should have been a red flag (and still is today) as far as finding a bargain.

Instead, look for stocks and securities that are less at the mercy of the broad market (and its sometimes irrational habits) and those that look to be strong fundamentally, but are perhaps underpriced. Rather than try to perfectly time the market, take a more long-term approach to the bargain purchase. Make sure it is a stock or security you would hold over the long-term, regardless of any short-term volatility.

Investors like Warren Buffett have made a career out of successful bargain hunting, but it is no easy task. Always be sure to do your homework when it comes to buying on the cheap and be prepared for the possibility that it may continue to fall. Your most powerful weapon is your research and knowledge of the security and how it relates to the wider market.

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