How to identify a dead cat bounce in stock markets?

A dead cat bounce in stocks terminology means a brief recovery of a falling stock. Learn how to recognise a dead cat bounce in share market and how to trade in dead cat bounce.

Identifying a dead cat bounce in stock market is often very difficult. Most beginning traders in stocks fail to recognize a dead cat bounce pattern, misinterpret as an upward movement and hold their shares (or even buys more, for worse), only to watch in despair the prices going further down. In this article, we will help you learn how to identify a dead cat bounce in stock market and stay away from it, especially if you are a beginner and you know exactly what you are doing. Nevertheless, before we proceed to discuss how to spot this pattern, let us attempt a working definition of dead cat bounce in stock markets for those who are hearing this name for the first time.

What is a dead cat bounce in stock markets?

Dead cat bounce graph cartoon
A dead cat bounce in stock market is a popular Wall Street term to refer to the brief, temporary recovery of the prices of a declining stock. Anything that falls from a great height bounces. Our Wall Street saying indicates even a very soft thing like a dead cat will bounce, however little, if it falls from a great height. The earliest use of the phrase dead cat bounce in context of stocks, as Wikipedia observes, was in 1985. That year as the stock markets of Singapore and Malaysia recovered a little from their steep decline, only to fall severely soon, two Financial Times journalists Horace Brag and Wong Sulong described the event as a dead cat bounce in the stock market. There is a similar proverb in the Cantonese language, which was perhaps the origin of the phrase dead cat bounce in stock market.

A dead cat bounce in stock market often looks like a reversal pattern in the prevalent trend of decline, while in reality it is only a continuation pattern which can only be recognized with hindsight. The brief upward move shortly stops and the prices fall further to surpass the prior low.

What are the reasons of a dead cat bounce in the market?

Chart of dead cat bounce in stock marketThere are several factors that cause dead cat bounce in stocks. Almost every bear market on this planet goes through a time when even the most ardent bears reconsider their situations. With a market consistently finishing down over a month or two, most bears clear short positions. At the same time, some value investors may think that this is the full fathom five, and momentum investors find oversold readings in their indicators. All these factors make the market go up together by applying a buying pressure, even though for only a while.

How to recognize a dead cat bounce pattern in stock market?

  • If there is a chart or graph available for the NAV or price of the stock(s) concerned, carefully examine it. Check out whether there is any somewhat steady decline pattern for at least a quarter.

  • If you stay updated about stock market news and the overall economic scenario of the world. That can greatly help you rationalize, at the first sight of upward movement, whether it is going to be a market reversal or a dead cat bounce. In stocks, several factors can temporarily reverse a steady fall; if you can identify those factors on time you can easily know when it is a bull, or when it is a bear in bull's disguise.

  • Filter sortable stocks. Avoid junks to felicitate a bearish strategy.

  • In contrary to the average long term investors, daily traders often love a volatile market and a dead cat bounce. Their experience and intuition help them recognize a dead cat bounce in stocks quite easily. If you know a daily trader, seek advice in the least suspicion of a dead cat bounce.

How to distinguish between dead cat bounce and stock market reversal?

Well, to be honest, there is no simple answer for this. At times, it is very difficult to tell whether it is a dead cat bounce or an actual market reversal. Patterns become clear only after the period is over, but then it is often too late to make any financial decisions. The only way to distinguish between market reversal and dead cat bounce is to use your experienced intuition and take calculated, educated risks. Nevertheless, these calculations still go wrong now and then. As a matter of fact, if everyone could successfully distinguish between dead cat bounce and market reversal, every trader would have made as much money as Warren Buffet did.

Courtesy: Investopedia, Investor Place, Wikipedia.


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