Bottom-Fishing

A lot of investors enjoy the challenge of bottom-fishing. There are many positives, but these same waters can be fraught with peril. A lot of investors wrongly assume that bottom-fishing and picking market bottoms is the same thing. They are not. You are not trying to call the end of a market downturn when you are bottom-fishing.

In bottom-fishing, the investor buys stocks that for one reason or another have seen new lows for the year or new multiyear lows. Those companies may have good fundamental businesses that are doing fine but, for one reason or another, have been beaten down by the market. On the other hand, picking market tops or bottoms deals with prediction, and that is a complicated feat to do on a regular basis.

BOTTOM-FISHING STRATEGIES
There are many strategies that an investor can employ when it comes to bottom-fishing. The following are some of the most popular that many investors and professionals use to identify the right stocks:

• Technical analysis: This is the use of charts and other chart-reading tools. These tools can help identify an oversold period in a stock that could signal a potentially good candidate. You could also look for chart formations to help identify fishing candidates.
  Advantages. You are using a method that does not rely on business or other fundamental factors. This can take the emotional side of investing out of the equation.
  Disadvantages. There are many patterns, and you spend a lot of time learning to identify and understand chart patterns. It is a time-consuming method that has often been described as an art. You will not be alone when it comes to chart-reading. Chart-reading is a popular tool for investors as well as professional traders.
• Fundamental analysis: You are looking at the fundamentals behind the stocks. You are looking at the business or industry that a particular stock is in. You are looking at balance sheets and comparing companies based on specific criteria. You are identifying good businesses that have been beaten down.
  Advantages. This is a method that Warren Buffett has been using. You can feel good by buying stocks that have been beaten down because you have identified coming growth and undervalued companies that can mean higher stock prices in the future.
  Disadvantages. It's time-consuming and difficult. Not many investors have the time to learn and understand all of the nuances of a company's balance sheet.
• Lows: Here you are looking for the lowest of the lows in a bear market '%C4' stocks that have lost 70% or more in one year, stocks that have hit new multiyear lows, or maybe prices that have never been seen before. Going after these stocks means you are buying something that has been beaten down for a long time.
  Advantages. With lows, you are able to take a bigger stake and buy at very low prices. With any decent rally, you can realize quick profits.
  Disadvantages. There is usually a reason that certain stocks have sustained heavy losses, and the risk of a company going out of business is much higher here. The chance of losing your invested capital is high.
• Blue chips: This strategy involves buying blue-chip companies that have been beaten down in a bear market. This is virtually the same strategy as fundamental analysis, except you are only buying blue-chip companies. These are the Wall Street bellwethers. These companies have survived many downturns, and no matter how bad things may look now, chances are high that these companies will be able to make it through the storm. You do not need to worry about fundamentals; you do need to worry about price points. A lot of investors will dollar cost average to help protect from buying on a false bottom.
  Advantages. Most of these companies are already in an investor's portfolio, so adding them at cheaper levels means the investors can have a bigger stake. You forgo short-term downturns for the potential future upside in the stock price.
  Disadvantages. Blue chips have gone out of business. There is usually a good reason why some blue chips have been beaten down to what on the surface may appear to be ridiculous levels. These could be signals of real fundamental problems with the business that may take a long time to fix -- if they ever get fixed, that is.

CONTRARIAN THOUGHT
The idea of bottom-fishing is a sensible one; you are attempting to find a bargain. There are two monumental hurdles an investor must overcome, however. First and perhaps the most challenging hurdle to jump over is contrarian thinking. During bear markets when bottom-fishing becomes popular, the sentiment on Wall Street and Main Street is not positive. It is difficult to look past all of the bad news and see the potential a company may have. It is not easy for investors to believe in themselves enough to make a pick based on their analysis of a company. No matter how that investor chooses the stock, it can still be difficult to pull the trigger on the trade.

Contrarian thinking is difficult in general for human beings, and it becomes that much harder when there is money on the line.

IDENTIFYING THE STOCKS
The second hurdle an investor will have to face is choosing the method he or she will use to identify these stocks. There are so many strategies, and picking the ones that you think will succeed is difficult, no matter what method you use. Bottom-fishing is a great idea, but there is a difference between buying a sweater at a deep discount from a store that is being liquidated and buying stocks of a company that has lost 70% or more of its market value in a short time. The most important factor is market timing. I stated at the beginning of this article that market timing was impossible to do consistently, and that is what makes bottom-fishing a challenge. You do not know if the stock price will go lower. Further, investors looking to bottom-fish need to prepare for the possibility of buying the stock of a company that may no longer exist in the near future. So while the upside is high and with time and patience you will be rewarded for the good picks, you want to limit your bad picks because those can be quite costly. How do you do that?

One of the best ways for an investor to identify a stock that is not a good candidate is to wait for a market rally. Market rallies will happen, even though they may sometimes be small. But if the sector of the stock is moving up but the stock itself is not, you may want to consider cutting your losses.

There is no way to know which stocks you bought will be winners in the future. Bottom-fishing can be rewarding as long as you are ready to face the potential pitfalls.