Two 'Falling Knives' to Steer Clear of Today

Editor's note: The bear market changed everything. Now, our colleague Greg Diamond says the market environment is changing again. In this piece, updated from his November 21 Weekly Market Outlook in Ten Stock Trader, he explains the danger and opportunity we're seeing now – along with two beaten-down stocks to avoid...

Not everyone realizes this... but we're in a new market environment. That means you shouldn't trade using the old playbook.

In that playbook, most stocks and sectors followed uptrends together and followed downtrends together. However, persistent inflation and the Federal Reserve's monetary policies have rewritten the old playbook of 2022.

Simply put, the U.S. just went through a recession.

The Fed won't admit this (nor will any Washington politician), but that's exactly what the central bank wanted to drive down inflation... and it worked. In 12 months, I bet you'll hear economists (who look at everything in the rearview mirror) state that we were in a recession. But now, everything is just fine.

The key point is that markets are forward-looking while economists are backward-looking.

Many stocks have already priced in the recession and are now looking forward. But some stocks, as I'll outline next, are going to struggle.

This is the new playbook... While inflation is coming down, interest rates are still very high.

Many investors and traders will feel confused about this transition and what comes next in the markets.

But not us.

Today, we're looking at two stocks that will likely struggle over the next few months...

One of the more popular sayings in trading is, "Don't catch a falling knife."

In other words, wait for the stock price to bottom out before buying.

Just because a stock is falling, and you can get in cheap, doesn't mean you'll make money on it. In fact, buying a cheap stock can hurt your portfolio as it continues to decline... It's like catching a falling knife.

The stocks we'll cover today lost more than 50% of their value last year. If I'm correct, they have much more downside ahead.

First up is Software as a Service business DocuSign (DOCU)...

From its August 2021 intraday high around $315, DocuSign dropped more than 80% in 2022. This is the definition of a falling knife. The stock will have a difficult time rallying above its 200-day moving average ("200-DMA") within this downtrend.

Second, we have payment-processing giant Block (SQ). Block has lost nearly 80% of its value from its August 2021 high...

I had recently considered trading this stock from the long side by buying calls (if it could make a new higher high). But the price action is telling me this isn't the right move... Block is likely to continue its downtrend.

Notice the blue box on the Composite Index ("CI") at the bottom of the chart above... Every time this indicator enters that blue zone, the stock price falls. The CI reached that zone again recently and dropped.

More than that, looking at the last major swing high in August 2022, notice how the recent rally stalled at the blue line. That's the Fibonacci retracement level. It shows where support and resistance are likely... in other words, the level where a stock is likely to reverse direction.

In the Block price chart, we can see significant resistance at that 61.8% level. The stock failed to punch through it, marking another failed swing high within the downtrend.

Right now, some stocks are doing great... while others, like DocuSign and Block, are losing most of their value. This is the new playbook for investors.

It also means we can make both short and long trades in the months ahead.

Remember, just because a stock has lost most of its value doesn't mean it's worth buying. That weak stock can keep dropping... So don't be left catching the knife.

Good trading,

Greg Diamond, CMT

Editor's note: Since last year's sell-off began, Greg has shown his readers opportunities to double their money six different times. And now, he's back with a new projection in 2023...

He'll share how a rare market event that has occurred just three times in 25 years could soon ripple through stocks this year. This inflection point offers generational moneymaking potential for folks who understand it... But it also involves a hidden danger for those who don't know what's coming.

Greg will reveal the full details in a free online event on Thursday, January 12. So don't miss it... Click here to learn more.

Further Reading

The past 40 years gave us low interest rates and soaring valuations. Now, that narrative has changed. And if you're going to find the best opportunities of this new market environment, you'll need to stay vigilant... Read more here: We're Living in a 'Stock Picker's Market'.

Tech stocks are in trouble – and the two names Greg shared today are only part of the story. One indicator recently flashed a warning for this sector... just like it did in the thick of the dot-com bust. Learn more here: This 'Tech Wreck' Signal Is Flashing Now.