Bottom Fishing: What it is, How it Works

What Is Bottom Fishing?

Bottom fishing refers to investing in assets that have experienced a decline, due to intrinsic or extrinsic factors, and are considered undervalued.

Understanding Bottom Fishing

A bottom fisher, a moniker given to investors who practice the bottom fishing strategy, speculates, using either technical or fundamental analytical techniques, that an asset's depressed price is temporary and will recover to become a profitable investment over time. Bottom fishing can be a risky strategy when asset prices are justifiably depressed or a savvy strategy when asset prices are trading at irrationally low valuations.

At its core, bottom fishing embodies the tried and true formula to trading the markets successfully, namely, buying low and selling high. Essentially, seek and invest in value. Many prominent value investors, such as Warren Buffett and Benjamin Graham, have amassed fortunes by purchasing assets that are trading at low valuations relative to their intrinsic worth and waiting for prices to recover to normalized levels.

As an investment strategy, bottom fishing has often been thought of as being more of an art form in that there is an abstract quality to its implementation. The key point to this art is to understand that a successful bottom fisher is not looking to buy a depressed security at its absolute low, but rather, buying it at the point where it has the highest probability of appreciation.

The risk in bottom fishing can best be summarized by the market aphorism that there is a reason for the price to be where it's at. Put simply, the market, being the excellent discount mechanism that it is, constantly adjudicates the value of a security and, if that security's value has depreciated sharply, there might be a valid reason, or reasons, for the depreciation. It is extremely difficult, if not impossible, to determine if this decline is simply due to a temporary factor, like panic selling, or is indicative of deeper issues that are not readily apparent.

Examples of bottom fishing include:

• Investing in the stock of an aluminum company when aluminum prices are depressed.
• Buying the stock of a container shipping company during an economic depression.
• Investing in a print media company when the internet is putting such companies out of business.
• Buying shares of a bank during a financial crisis.

In each of these cases, it is unclear when or if the stock's price will recover, although arguments could be made in either direction. Investors who purchased banking stocks during the 2008 financial crisis generated significant returns, while investing in print media companies may have produced losses since the industry has never managed to recover from the intensifying competitive pressures fully.

Bottom Fishing Strategies

Bottom fishing is attractive due to the greater profit potential relative to fairly valued or overvalued assets. Predictably, bottom fishing is most popular in prolonged bear markets.

The most popular bottom fishing strategy is known as value investing. By looking at valuation ratios and projecting future cash flows, value investors focus on identifying opportunities where the market may be incorrectly pricing assets. A great example would be a company that experienced a bad quarter due to a supply chain issue and experienced a significant decline. Value investors may determine that the incident is isolated and purchase the stock in the hopes that it eventually recovers to trade at a valuation that's more comparable to its peers.

Many traders also use technical analysis to identify oversold stocks that may be attractive bottom fishing opportunities. For example, a company may report lower than expected quarterly financial results and experience a significant price decline. Traders may notice that selling pressure is starting to subside and decide to take a long position to capitalize on the short-term rebound. Oftentimes, these traders may use technical indicators that are helpful when assessing whether a security is oversold or look at candlestick chart patterns to make similar determinations.

Investopedia does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Investing involves risk, including the possible loss of principal.