For example, the price moves above a prior swing then drops but stays above the prior swing low, and then moves back above the swing high. That indicates that the asset is on an uptrend but that a reversal is underway. Dead cat bounces also occur in ETFs or how to buy mft share baskets, which are composed of many stocks. For example, our China Tech share basket shows a long-term downtrend as the Chinese government cracked down on big technology companies in 2021 with anti-monopoly legislation and fines. The best way to learn how to spot it is to review the charts of stocks or other assets that are in downtrends.
A “dead cat bounce” is a term used in financial markets to describe a temporary recovery in the price of a declining stock or market. While it might appear to signal a reversal, it is followed by a continuation of the initial decline. In 1986, a columnist writing about falling oil prices suggested coining the term on bumper stickers. He explained that recovering oil prices should not be mistaken for renewed stability as an asset was still “dead” like a cat that bounced after falling but did not regain life.
News and events
We’ll review how to identify them using stock charts and compare them to other patterns so you can add them to your trading arsenal. The term originated from Wall Street in the 1980s, based on the idea that “even a dead cat will bounce if it falls from a great height”, referring to brief market recoveries in a broader downtrend. This method helps traders structure dead cat bounce setups with clearer risk-reward ratios.
- During bear markets, indices like Nifty 50 or Sensex may experience temporary rallies.
- The limitations of dead cat bounce are mainly focused on the difficulty of identifying it.
- In 1986, a columnist writing about falling oil prices suggested coining the term on bumper stickers.
- A dead cat bounce can be seen in the broader economy, such as during the depths of a recession, or it can be seen in the price of an individual stock or group of stocks.
Dead cat bounce in stocks and trading strategy
In the B2B sector, where investments and financial strategies play a pivotal role in partnerships and operations, understanding the nuances of market movements like the dead cat bounce is invaluable. The somewhat morbid expression is believed to have originated from the idea that even a dead cat will bounce if it falls from a great height. In financial markets, this metaphor is web application and software architecture 101 learn interactively used to describe a situation where a stock, currency, or index experiences a short-lived recovery amidst a prolonged decline. It’s important to note that this recovery is typically not indicative of a reversal in the negative trend. Traders can look for certain indicators to identify a Dead Cat Bounce, such as a sharp decline in price followed by a quick rebound on lower trading volume.
- But after the dust settled, investors saw value and shares rebounded.
- The dead cat bounce can apply to both markets as a whole or single stocks that are in decline.
- This chart illustrates just where the cat bounced, how high it bounced, and then how far it continued to fall.
- Despite a dead cat bounce being a lagging or trailing indicator, you can still trade it.
- In this section, we will explore the various signs, tools, and indicators that can help in accurately identifying a dead cat bounce chart movement.
Crude oil prices, for example, have historically experienced brief rebounds when OPEC announces production cuts. However, if global demand remains weak or inventories continue to rise, these rallies tend to fade. In conclusion, the dead cat bounce serves as a reminder of the need for vigilance and informed analysis in the financial sector.
The temporary nature of the rally indicates that buying pressure is not sustained by fundamental improvements or a widespread shift in investor confidence. Instead, it often reflects technical adjustments or short-term speculative activity. This temporary price increase often indicates a brief period of buying interest or short covering within an otherwise negative market. It can create a false sense of optimism, leading some to believe the market has found its bottom. However, the underlying sentiment remains predominantly bearish, and the asset resumes its downward path after this short rally. The bounce is merely a reflex within a larger decline, reflecting fleeting market dynamics.
What Is a Dead Cat Bounce in Trading and How Does It Work?
A dead cat bounce is an investing term for the temporary rise in the price of a stock or other asset during a long period of decline. The morbid term comes from the idea that if it falls far enough, even a dead cat will bounce. The standard usage of the term refers to a short rise in the price of a stock that has suffered a fall. In other instances, the term is used exclusively to refer to securities or stocks that are considered to be of low value.
It is important also to understand that dead cat bounces are often only recognized in hindsight and are difficult to predict in real-time as an unreliable signal of an actual market bottom. With the different time frames, it’s possible to have a dead cat bounce on a shorter time frame within a dead cat bounce on a longer time frame. It varies, but typically lasts a few days to a few weeks, depending on market conditions and trading volume. At the same time, short-sellers may cover positions, temporarily driving prices up. This entire pattern—the sharp fall, brief rebound, and renewed decline—is the classic dead cat bounce. A long-term time horizon should calm the fears of those invested in stocks, making the short-term bouncing cats less of a factor.
How the pattern plays out in stocks
Trading volume patterns during a dead cat bounce are distinctive, often appearing lower compared to the volume during the preceding decline. This reduced volume suggests a lack of strong buying conviction, indicating that the rally is not supported by broad market participation. The duration of such a bounce is brief, lasting from a few days to a few weeks, before the downtrend resumes.
A dead cat bounce is a short-lived gain in a declining asset’s price followed by another steep drop. This can happen because of news, market speculation or weak fundamentals. In general, investors should be cautious when it comes to jumping into an asset based on a short-lived price increase. Instead, long-term investors should focus on the asset’s fundamentals rather than relying solely on how the price is moving.
Frequently, downtrends are interrupted by brief periods of recovery—or small rallies—during which prices temporarily rise. Real estate markets also experience similar patterns, though over longer timeframes. During housing downturns, temporary price rebounds may occur due to short-term demand spikes, government stimulus programs, or lower mortgage rates. However, if broader economic conditions such as rising unemployment or high interest rates persist, these recoveries often prove unsustainable. The 2008 housing crisis saw multiple instances where home prices temporarily stabilized before continuing their decline, particularly in overleveraged markets like Florida and Nevada. Bear markets frequently see multiple dead cat bounces before reaching a true bottom.
Consider the stock of the major financial institution Wells Fargo (WFC 0.26%), which traded at about $53 per share at the start of 2020. When the COVID-19 pandemic hit, fears of loan defaults and plunging consumer interest rates caused the bank stock to lose significant value. By the beginning of April, the stock price had declined trading tutorials and platform video guides to about $26.
Psychological Impact on Investors
As the early buyers sell, new buyers and sellers become more aggressive on the bounce. The extreme nature of the drop in terms of the magnitude and the speed preceding the bounce distinguishes a dead cat bounce from a typical breakdown. However, a phenomenon unique to certain bear markets, including the one described above, is the occurrence of a dead cat bounce. After declining for six weeks in a row, the market showed a strong rally. The Nasdaq in particular posted gains of 9% after a disappointing string of losses.