The Distressed Company Trading System & Strategy involves a bet that a company experiencing severe financial difficulties is essentially not as distressed as the market believes. When a company undergoes severe hardship and becomes distressed, many investors react by selling shares and this can drive the stock price below fundamental levels.
Distressed companies can therefore be attractive to opportunistic traders looking for a bargain.
Furthermore, there are different forms of bankruptcy which can help the distressed investor.
Chapter 7 bankruptcy will involve liquidation of assets which means investors could still get a payout.
Meanwhile, under a Chapter 11 bankruptcy, the company is given permission to continue trading and reorganise which could lead to significant improvement down the road.
The following chart from Barclay Hedge shows how the Edhec Distressed Securities Index has outperformed the S&P 500 since 2000:
The Distressed Company Trading System & Strategy:
The distressed securities anomaly holds that some distressed securities become undervalued through forced selling and investor psychology.
To really succeed you need to understand balance sheets and the logistics of distressed companies.
Ideally, you should have experience of picking companies that could offer a return after liquidation of assets or after a company reorganization.