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What is the status of Falling Knife? How not to lose your capital in cryptocurrency

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What-is-the-status-of-Falling-Knife-How-not-to-lose-your-capital-in-cryptocurrency

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It has probably happened to you that the price of an asset is falling and you have started buying that asset thinking that the prices have become very reasonable.

But contrary to expectations, unfortunately, the price drop has continued beyond your imagination and instead of profit, you have suffered a loss.

Such a situation is called a falling knife (Falling Knife) and this term is common in investment or trading.

In this article, we will explain the reasons for the Falling Knife, along with its advantages and disadvantages, and examine examples of the formation of this pattern in the digital currency market.

Let’s dive in and explore together:

What is Falling Knife?

Falling Knife is a trading pattern or rather a trading fact that refers to an asset or digital currency whose value is drastically decreasing.

There is no definitive number for how much the price declines, but generally speaking, the term refers to a situation where the price of an asset has rapidly declined by more than 20% from its 52-week high.

The term “catching a falling knife” is used to warn traders and investors not to rush into buying an asset, Simply because it has been reduced in price and therefore looks cheap. Buying in a falling market can be very risky, Just like trying to catch a falling knife that could hurt your hand.

There is a simple reason for this risk:

“The fact that the price of an asset drops by 30% to 50% does not mean that it cannot go down by another 80%.”

For example, during the dot com bubble crisis of 2000, when the stock price of Internet startups fell by more than 50%, traders began buying them because they thought they would make huge profits. But a long time after that, the price of many of these shares reached zero.

Falling Knife pattern

A falling knife pattern is often formed after a large price move and appears on the price chart as a sharp drop that goes straight down without stabilization or pause.

As shown in the chart below, a falling knife pattern is formed by a series of consecutive bullish and bearish candlesticks.

Bitcoin Falling Knife

Inexperienced traders believe that the formation of a falling knife pattern provides an opportunity to buy an asset at a discount. One of their common mistakes is to buy at the first level of the next support without paying enough attention to the momentum of the price movement.

The reason for this mistake is that if the price falls below that support level, it will likely continue to decline until it finds new support at lower levels.

A good example was in April 2022, when Bitcoin fell from around $45,000 to $39,000. Some traders saw this as an opportunity to buy cheap bitcoins. But a month later, the price of Bitcoin dropped another $10,000 and reached below $30,000. Just a few days later, the price fell below the $20,000 level.

Reasons for forming the Falling Knife pattern

The factors that cause an asset’s price to free fall are complex. Some of them are:

An example of the Falling Knife pattern: the Terra-LUNA crisis

One of the best recent examples of the formation of the Falling Knife pattern is the Terra-Luna project crisis, which completely collapsed within 10 days:

Dos and don’ts of Falling Knife, Advantages and Disadvantages

Trading with this model has its own advantages and disadvantages, which we mention both. However, the disadvantages of Falling Knife outweigh its advantages:

Tips for trading the Falling Knife pattern

Trading the Falling Knife pattern is a risky strategy that can be very profitable if done correctly. But note that this work requires a lot of patience, discipline and skill.

Here are some tips for catching a falling knife without getting hurt:

Use of technical analysis

Use technical analysis by observing these signals:

Watch out for the Dead Cat Bounce pattern

A dead cat bounce pattern is when the price drops quickly and then suddenly reverses and starts to rise. However, this rise is usually temporary and the price will continue to decline.

This can be a trap for investors who think the price has dropped and start buying.

Using the Dollar Cost Averaging (DCA) strategy

When you see an asset drop in price by 50%, it’s very tempting to buy all at once, but doing so can be a big mistake. Because the reason that the price of an asset has decreased by 50% does not mean that it cannot decrease by another 50% or 60%.

Buying in increments helps you still have money to buy even when prices drop.

Using limit loss and limit orders

If the price continues to fall, using these types of orders will help reduce your losses.

The Falling Knife investment strategy can be a risky way to make a profit that rarely happens. However, remember to use it with caution and not take too many risks.

In what cases should you not trade with the Falling Knife pattern?

In these cases, do not try to catch the falling knife, when:

Trading with the Falling Knife pattern? Yes or No

Buying and selling with the Falling Knife pattern is not easy at all. The best course of action is to wait for prices to correct, pull back, and resume an uptrend before you start buying.

However, if you have a high risk tolerance and are not afraid of catching a falling knife, we recommend that you grab the knife by the top of the handle. This means that in such a situation, instead of buying and long trading positions, go for a selling position.

You have to be skilled enough to make sure this pattern is a Falling Knife and not a Bear Trap though.

The main rule is not to pick up a falling knife. There are many trading positions in the market. Our advice is to avoid high risk.

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