Trying to catch a falling knife is generally not considered to be the right idea as it is difficult to gauge where these stocks would stop declining. Stocks that are in freefall can plunge even below the wildest guess of investors and it is the very reason that if a reversal is caught at the right time, the rewards could be quite good.
Hence only high-risk appetite traders should attempt to catch a bottom. The share price of One 97 Communications Ltd (NS:) (PayTm) has been tumbling for the last few sessions. The company’s market capitalization has also been reduced to INR 29,367 crores, tumbling below the INR 30,000 mark for the first time since its listing. Looking at the intensity with which the stock tanked to a new all-time low, there’s no doubt that trying to catch a bottom in this counter is not an easy task.
Image Description: Daily chart of PayTm
Image Source: Investing.com
But, the same selling spree that is going on is the very reason that makes it one of the best candidates for a mean reversion trade. It is a type of trading wherein traders try to bet in the opposite direction of the broader trend after the stock deviates significantly from its estimated mean price. In simple words, it is the same thing when traders buy the oversold stock and sell the overbought one.
Yesterday, the RSI (daily, 14) indicated a reading of around 14.3 which is the lowest since the listing. This denotes an extremely oversold status of PayTm shares and therefore estimating a counter-trend rally from here would not be a bad idea. Today, the stock surged over 6% to INR 467.6, by 11:55 AM IST, which is the highest one-day gain (in %) since August 2022. This is probably the first sign that investors are getting lured looking at these never-before-seen prices.
Another thing, the stock also crossed its previous day’s high of INR 467, the first time after 14 November 2022. There’s no question that the stock is still in a very strong downtrend, however, the signs of a counter-trend move are materializing on the chart. If the stock is to reverse from here, a rally till INR 527 – INR 530 could be a piece of cake. These rates could come on the screen in the next few sessions. The worst that could happen is that the stock might fall again to make new lows, but the beauty of mean reversion is that the exit levels in case of a loss are quite near as compared to the profit levels. So, the risk-to-reward ratio becomes quite favorable in these setups.