A Dead Cat Bounce is derived from the saying “even a dead cat will bounce if it falls from a great height” which indicates a brief recovery in the price of a declining asset that is shortly followed by a continuation of the downtrend.
Most traders fall into this trap if they’re not careful enough and this article will help understand how dead cat bounce works, and how to spot one quickly.
What Is Dead Cat Bounce?
A dead cat bounce is a brief, temporary recovery of asset prices from a prolonged decline or bear market, followed by the continuation of the downtrend. Downtrends are frequently broken by brief periods of recovery—or small rallies—during which prices temporarily rise.
It often occurs when a declining cryptocurrency suddenly regains some of its value before continuing to fall. In other words, a dead cat bounce is a fictional increase in the value of an asset caused by short-term market fluctuations.
Understanding Dead Cat Bounce
A dead cat bounce is a price pattern that technical analysts employ. It is a continuation pattern in which the bounce appears to be a reversal of the prevailing trend at first but is quickly followed by a continuation of the downward price move. After the price falls below its previous low, it becomes a dead cat bounce (rather than a reversal).
Downtrends are frequently interrupted by brief periods of recovery or small rallies in which prices temporarily rise. This can occur as a result of traders or investors closing out short positions or purchasing on the assumption that the security has reached a bottom.
A dead cat bounce is a price pattern that is usually identified in retrospect. Analysts may use technical and fundamental analysis tools to predict that the recovery will be only temporary. It can also occur in the broader economy, such as during a recession, or it can occur in the price of a single stock or group of stocks.
Identifying it ahead of time is difficult, even for experienced investors, in the same way, that identifying a market peak or trough is. In March 2009, for example, New York University economist Nouriel Roubini referred to the nascent stock market recovery as a “dead cat bounce,” predicting that the market would quickly reverse course and plummet to new lows. Instead, March 2009 marked the start of a long bull market that eventually surpassed the pre-recession high.
How to Spot a Dead Cat Bounce
Unfortunately, there is no easy way to identify it but here are some key characteristics to look for:
- If the cryptocurrency’s price falls consistently
- If the crypto coin regains value for a limited amount of time
- If the crypto coin depreciates again falling below its previous low
As you can see from these characteristics, detecting it might seem to be very difficult. You can’t tell the difference between a rally, a revaluation, and a dead cat bounce until it happens.
Dead Cat Bounce Example
Consider the following historical example. Cisco Systems stock peaked at $82 per share in March 2000 before plummeting to $15.81 in March 2001 as the dot-com bubble burst. Cisco witnessed numerous dead cat bounces over the years. By November 2001, the stock had recovered to $20.44, only to fall to $10.48 by September 2002. In June 2016, Cisco was trading at $28.47 per share, less than one-third of its peak price during the 2000 tech bubble.
A more recent example is the market’s reaction to the onset of the global COVID-19 pandemic in the spring of 2020. Between the weeks of February 21 and February 28, 2020, US markets lost approximately 12% as headlines began to hit and panic flared up.
The market rose 2% the following week, giving some people the impression that the worst was over. However, this was a classic dead cat bounce, as the market fell another 25% over the next two weeks. Markets did not recover until the summer of 2020.
How Does a Dead Cat Bounce Happen?
A dead cat bounce is typically the result of short-term speculation. Short-term traders, such as day traders, typically buy declining assets in the hope of making a small profit in a single day. This is due to the fact that they profit from short-term fluctuations.
This interest can sometimes cause the value of a cryptocurrency to rise, generating even more interest from buyers who jump in when they see the cryptocurrency’s price rise. This can cause the cryptocurrency’s value to temporarily rise until the traders sell the cryptocurrency again.
It is also said to occur when sellers exit their positions.
Most traders will short-sell a cryptocurrency if it appears to be overpriced, expecting the price to fall. When a large number of traders exit a short-sale position, it triggers a wave of buying, causing the price of cryptocurrencies to rise in the short term. This can sometimes attract more traders to the market, causing prices to rise even further. However, the benefits are fleeting.
FAQs
What Causes a Dead Cat Bounce?
Reasons for the occurrence include a clearing of short positions, investors incorrectly believing the bottom has been reached, or from investors trying to find oversold assets. Ultimately, the dead cat bounce is not founded on fundamentals and so the market continues to decline soon after.
How Long Can a Dead Cat Bounce Last?
A dead cat bounce typically lasts only a few days, although it can sometimes extend over a period of a few months.
What Is the Opposite of a Dead Cat Bounce?
An inverted dead cat bounce is a temporary and often severe sell-off during an otherwise secular bull market. It has many of the characteristics of a dead cat bounce but in reverse.
