Is "don't catch the falling knife" a good strategy for an everyday investor?

Question

Until recently, my understanding was that "crab investing" is the best strategy for an "everyday investor":

Crab investing: Every pay check, buy (and hold) a diverse range (index fund) of stock, irrespective of if the market was up or down.
Everyday investor: Someone who's day job is not investing, and retirement is 10+ years off

However, the other day, I heard that the "don't catch the falling knife" strategy may be better in the long run:

Don't catch the falling knife strategy: Each paycheck, if the closing price yesterday was higher than the month before then buy. Otherwise put the money in a savings account until the next month. When the next month rolls around, repeat, putting all of the saved money in as well.

On the face of it, it looks like you will miss out on some gains due to short term volatility, but will be making the best of long term market downturns. This sounds good in theory, but:
Does the "don't catch the falling knife strategy" work better in practice than simple "crab investing"?:
Is there an ideal period (weekly, monthly, 2 monthly, etc.) to use?

Robin Garnham · Accepted Answer

Interesting idea. Don't catch the falling knife strategy sounds like you're buying while the stocks are appreciating (e.g. they are trending up) - which seems like the opposite to the Warren Buffett advice:

Be fearful when everyone else is greedy. Be greedy when everyone is
fearful.

I think Crab investing is the way to go, dollar cost averaging spreads your risk.

Michael · Answer

I created a simulation to test the performance of cash, crab, and "falling knife" strategies in a variety of random market conditions.  What I found is that in a rising market, the "crab" strategy outperforms both "falling knife" and "cash".  In a roughly flat market, all three strategies are roughly the same performance.  In a falling market, "cash" outperforms "falling knife" which outperforms "crab".

The basis for long term investing is that - over time - the market trends is up.  In such a case, the "crab" strategy will outperform, regardless of short-term movements of the market.  Assuming you could time the market, the "falling knife" strategy is still outperformed by cash in a down market.

Is "don't catch the falling knife" a good strategy for an everyday investor?

2 Answers

Add your own answers!

Ask a Question