What is a dead cat bounce?
A dead cat bounce is a temporary, short-lived rally in asset prices after a prolonged decline or a bear market followed by the continuation of the downtrend. Frequently, downtrends are interrupted by brief periods of recovery, or small bounces, during which prices temporarily rise.
The name “dead cat bounce” is based on the idea that even a dead cat will bounce if it falls far enough and fast enough. It is an example of miller’s rally.
Key points to remember
- A dead cat bounce is a short-lived and often sharp rally that occurs in a secular downtrend.
- This is a rally that is not supported by fundamentals and is reversed by downward price movement.
- In technical analysis, a dead cat bounce is considered a continuation pattern.
- At first, the rebound may seem like a reversal of the prevailing trend, but it is quickly followed by a continuation of the price decline.
- Dead cat bounce patterns are usually only realized after the fact and are difficult to identify in real time.
What does a dead cat bounce tell you?
A dead cat bounce is a price pattern used by technical analysts. He is considered a continuation pattern, where at first the rebound may appear to be a reversal of the prevailing trend, but it is quickly followed by a further decline in price. This becomes a dead cat bounce (not a reversal) after the price fell below its previous low.
Often downtrends are interrupted by brief periods of recovery or small rallies, when prices rise temporarily. This can be the result of traders or investors closing short positions or buy assuming the stock has bottomed out.
A dead cat bounce is a price model which is generally recognized in hindsight. Analysts can attempt to predict that the recovery will only be temporary using certain techniques and fundamental analysis tools. A dead cat bounce can be seen in the broader economy, such as in the depths of a recession, or it can be seen in the price of an individual stock or group of stocks.
Short-term traders may try to take advantage of the small rally, and traders and investors may try to use the temporary reversal as a good opportunity to initiate a short position.
Similar to identifying a market peak or trough, recognizing a dead cat bounce in advance is fraught with challenges, even for skilled investors. In March 2009, for example, the economist Nouriel Roubini, of the University of New York, evoked the nascent stock market recovery as a dead cat bounced predicting the market would quickly reverse course and plunge to new lows. Instead, March 2009 marked the start of a long bull marketeventually surpassing its pre-recession peak.
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Examples of a dead cat bounce
Let’s take a historical example. Cisco Systems’ stock price peaked at $82 per share in March 2000 before dropping to $15.81 in March 2001 amid the dot com meltdown. Cisco has seen many dead cat bounces in the years since. The stock rallied to $20.44 in November 2001, falling to $10.48 in September 2002. Fast forward to June 2016 and Cisco was trading at $28.47 per share, barely a third from its peak price during the tech bubble of 2000.
A more recent example is the price action in the market following the onset of the global COVID-19 pandemic in the spring of 2020. Between the week of February 21 and February 28, 2020, US markets lost around 12% as the headlines started banging and panic set in. The following week, the market rose 2%, giving some the impression that the worst was over. But it was a classic dead cat bounce, as the market then fell another 25% over the next two weeks. It was only later, during the summer of 2020, that the markets recovered.
Limitations in Identifying a Dead Chat Bounce
As mentioned above, most of the time a dead cat bounce can only be identified after the fact. This means that traders who notice a rally after a sharp decline may think it is a dead cat bounce when in reality it is a trend reversal signaling an extended recovery.
How can investors determine if a current upward move is a dead cat bounce or a market reversal? If we could answer this question correctly all the time, we could make a lot of money. The fact is, there is no simple answer to spotting a market bottom.
How long can a dead cat bounce back?
A dead cat bounce usually only lasts a few days, although it can sometimes extend over a period of a few months.
What causes a dead cat to bounce back?
Reasons for a dead cat bounce include offsetting short positions, investors mistakenly believing that bottom has been reached, or investors trying to find oversold assets. Ultimately, the dead cat bounce is not based on fundamentals and so the market continues to decline soon after.
What is the opposite of a dead cat bounce?
A reverse dead cat bounce is a temporary and often severe sell-off in an otherwise secular bull market. It has many of the characteristics of a dead cat bounce, but upside down.
The essential
When markets fall, a relief rally may lead investors to believe that the worst is over. However, it could just be a dead cat bounce: a strong bull run in an otherwise secular bear market. Those who get caught in a dead cat bounce can suffer losses as timing market lows is extremely difficult and risky.