top of page
Writer's pictureInvex Global

Understanding Dead Cat Bounce and How to Spot It



A Dead Cat Bounce is a curious term that has nothing to do with feline acrobatics or humor. It describes a common scenario in finance where a stock (or other asset) appears to experience a short-lived recovery after a significant decline, only to continue its downward trajectory.


What makes a Dead Cat Bounce difficult to identify is that it can sometimes look and feel like a potential reversal in a major downtrend. It's not uncommon for investors to get excited when they see a sudden surge in the price of a stock that has clearly been falling for some time, only to be disappointed when the short-term rebound is followed by even steeper losses.


Why Do Dead Cat Bounces Happen?


There are several reasons why a dead cat bounce can happen. One of the most common is that investors and traders start buying a stock that has experienced a significant decline, hoping to capitalize on a potential rebound. This buying activity can temporarily drive up the price of the stock, creating the illusion of a recovery.

Another factor that can contribute to a dead cat bounce is market volatility. Markets can be unpredictable, and sudden changes in investor sentiment can cause sharp fluctuations in asset prices. In some cases, a sudden rally in a stock or market index can be the result of a short-term surge in market optimism, rather than any significant change in the underlying fundamentals of the company or market.

Sometimes, a dead cat bounce can also occur as a result of technical factors. For example, a stock may be oversold, meaning that it has experienced a prolonged period of declining prices, and is due for a bounce back. This technical rebound can be short-lived, however, if the underlying fundamentals of the company or market haven't improved.

How to Spot a Dead Cat Bounce: A Simple Guide for Beginners


First, you need to look for a financial asset that was previously on an upward trend but has suddenly declined sharply within a short period. This could be a stock, cryptocurrency, or currency pair.


Then, watch for a sudden jump in the asset's value after the decline. This jump is often driven by buyers looking to take advantage of the asset's lower price. However, the jump is usually brief and is followed by further declines.


Picture this: a stock that had been soaring to new heights, its trajectory seemingly never-ending. One day, it plummets from $70 per share to a mere $40. After a couple days of struggling, it makes a remarkable recovery, rocketing up to $50 per share. But this momentary success is short-lived and the stock quickly plunges back down to $30. This tumultuous jump from $40 to $50 is what's known as the "dead cat bounce."


In other words, with the right knowledge and an attentive eye on your investments, you can spot the dead cat bounce and make more informed financial decisions – avoiding any false sense of security caused by temporary recoveries.


When does “dead cat bounce” happen?


When the stock market takes a tumble after a significant announcement, it's known as a dead cat bounce. Whether it's an unexpected earnings report, the resignation of a CEO, or an unimpressive product launch, these news-driven dips can be felt across stocks, currencies and commodities alike.


Even central bank decisions such as adjustments to interest rates and negative economic data like employment and manufacturing PMIs can lead to sudden drops in prices. Whatever the cause, don't be too alarmed by these short-term price movements; they're often just dead cats bouncing.


Dead Cat Bounce vs Market Reversal: What's the Difference?


When trading stocks, it's essential to know the difference between a dead cat bounce and a market reversal. A dead cat bounce is a short-lived price rally that happens after a significant decline. It usually lasts between three to 15 price bars before the asset's price continues to drop again. In contrast, a market reversal signals a change in trend direction and can last more than 20 days, indicating prolonged buying or selling.


When analyzing a dead cat bounce, traders should also consider the magnitude of the upward price move. If the price goes above prior swing highs, it could indicate that a reversal is underway. Conversely, if the price remains above prior swing lows, it may signal an uptrend is forming.


Additionally, traders should also look out for bull traps, which are similar to dead cat bounces but more deceptive. A bull trap occurs when the price moves above a prior swing high or resistance area before quickly reversing to the downside, trapping traders and investors who thought the trend was reversing.


Bottom Line


A Dead Cat Bounce is a phenomenon in finance where a stock experiences a short-lived upward trend following a significant fall in value. This can occur for various reasons and can be misleading to investors who may believe that the stock is on the road to recovery. In reality, it's often just a temporary blip that doesn't indicate true long-term growth. This kind of bounce-back can be particularly dangerous for novice investors who may be tempted to invest in the stock, thinking they are getting in at a bargain. However, it's important to recognize that a Dead Cat Bounce may not be a good opportunity for short-term gains and that long-term investment strategies are often a safer bet.

21 views0 comments

Comments


bottom of page