Dead Cat Bounce

In financial markets, a temporary recovery or rally in the price of a deteriorating asset, such as stocks, is referred to as a Dead Cat Bounce. The term “Dead Cat Bounce” suggests that even when a cat is dead, it will bounce if it falls off high points; however, they remain lifeless.

Also, within finance “bounce” serves as shorthand for a brief uptick amidst general downward trading which generally precedes further downtrend instead of reversed momentum. It is an upward shift that is temporal and does not signify any change in the prevalent downtrend filiation; italicized words have been inserted here for clarity. 

Understanding Dead Cat Bounce

The purpose of seeking out a dead cat bounce is to determine if a stock or other asset that increases its worth following an elongated decline would continue with that trend. If for instance I have short-sold some stock and see an upward price movement in the form of a dead cat bounce, I might decide not to cover my short position thereof. On the other hand, if an investor’s perspective on price action contends that this is an ongoing rally that can sustain itself over time then he/she would be forced to terminate their sale before covering it completely so one not to incur more losses as there was bearish trading earlier and afterwards it turned to be a bullish market again. 

A dead cat bounce is a technical term used by stock analysts when they need to tell someone that they do not favor their job. Typically for us, learning the basics about any company would do better than looking at charts to achieve above-average returns in a stock market. 

However, it is essential that you become conversant with some of the fundamental terms used by technicians dealing with stock exchanges, including patterns of the stock price. This may be an indication of whether the growth of the price of the stock is due to a business gaining ground or just because a stock might seem cheap when its price has been declining over long periods. 

Characteristics of Dead Cat Bounce

Here are some of the crucial characteristics of Dead Cat Bounce: 

Temporary Recovery 

Temporary Recovery refers to a brief increase in the price or value of an asset that has been falling sharply.   

Downward Trend  

When it makes a quick fix back up on occasion, prices they are travelling typically fall again and often decline below former bottom levels, sometimes well beyond former lows. 

High Volatility 

Dead cat bounces are generally seen as having a particularly high level of volatility because they coincide with general negative sentiment and therefore plastic investor response. 

Low Volume Trading 

The bounce usually happens on low trading volumes which do hint that prevailing broad market sentiments are negative even with the temporary rise in prices.  

Psychological Impact 

The psychological impact of such a fair-trading scenario is that an inexperienced trader may be misled into believing that the trend is about to change and therefore buy into it; after all, prices do not always go up but sometimes rather collapse even more after a bounce ends. 

Causes of Dead Cat Bounce

Typically, a dead cat bounce is caused by a combination of factors involving both  

Psychological and market-related aspects. 

Short Covering 

Short covering occurs when traders in a bear market who had sold short previously (betting on the asset’s price downfall) decide to cover their positions so that they can lock in profits or hedge against losses, a situation that might result in a momentary surge of purchasing pressure thereby pushing prices upwards. 

Technical Rebound 

A technical trader can detect oversold situations after a large fall using indicators like RSI or moving averages, thus triggering automated buy signals or prompting traders to go long on speculations, hence causing a short rally. 

News or Rumors 

Positive news, rumors of potential acquisitions, regulatory changes, and other events that move markets can lift investor sentiment temporarily, resulting in a short-term spike in buying activity. 

Market Sentiment Shifts 

Investors’ feelings might swing temporarily due to sanguine economic numbers, company news, or international events. Such moves could lead to a perception that a slide in an asset has stopped – at least for a while. 

Investor Psychology 

In the world of investment, the emotions of people largely dictate how the market behaves. The Dead Cat Bounce takes place when individual traders tend to take a view at a stock/instrument as if it were underpriced after tumbling abruptly. This creates an impression that investors will buy back into it momentarily without any rational reasons because the price is right before the market reverts to its normal trends. 

Liquidity and Trading Dynamics 

When there is little trading volume or liquidity constraints, price movement can be worsened in either direction. Such a situation can lead to a temporary upward surge in prices due to a lack of sellers. 

Examples of Dead Cat Bounce

Here are a few notable examples of Dead Cat Bounce scenarios from financial markets: 

Stock Market Crash of 1929 

After the amicable improvements in the value of stock prices in some days the previous month, the traders observed a drop in these shares’ prices. It should be noted that the stock prices never dropped every day consecutively. Some days before the crash, the US government tried to allure citizens back into buying stocks by assuring them that there would be no drop in the cost of land. 

Dot-Com Bubble (2000-2002) 

The crash of the Dot-Com Bubble (2000-2002) affected a lot of internet and tech stocks, so they went down a lot. Some stocks temporarily regained value in a few instances then resumed downtrends after the market correction. 

Financial Crisis of 2007-2008 

The Global Economic Recession of 2007-2008 experienced multiple episodes of dead cat bounces scampering in numerous financial institutions as well as housing sites after an initial downfall of their shares. As a result of the upheaval in the market with occasional government interventions such as intermittent bailouts, different attempts made to pull through kept on stalling in between due to the persistence of economic fears. 

Bitcoin (2017) 

The price of Bitcoin jumped significantly towards the end of 2017 before splitting into two parts; one part stood at almost $20,000 as December came around while falling steeply in early 2018. The temporary rises in price were however reflective of speculation and not long-term trends. 

Energy Stocks (2020) 

According to the stats about Energy Stocks in 2020, many energy stocks faced extreme price drops during the Covid-19 pandemic and oil prices crashed in early 2020 where some companies experienced momentary gains as markets looked forward to production cuts or economic revival only for them to register even more losses due to uncertainty about worldwide demand patterns. 

Frequently Asked Questions