Dead Cat Bounce: Did it Bounce or Not?
Updated: Apr 7
When the financial market suffers from a consistent fall, traders will see this as an opportunity for buying stocks hoping to gain profit. If they buy it too soon there will be a small and temporary increase in price. This is what we call a “dead cat bounce”. According to Investopedia, a dead cat bounce is a temporary recovery of asset prices from a prolonged decline or a bear market that is followed by the continuation of the downtrend. As we can see in the graph below, downtrends are often interrupted by short periods of recovery where prices temporarily rise. The name "dead cat bounce" is based on the idea that even a dead cat will bounce if you drop it from a great height.
The expression “dead cat bounce” was first used in the news media in December 1985 when the Singaporean and Malaysian stock markets bounced back after a hard fall during the recession of that year. Journalists Horace Brag and Wong Sulong from Financial Times quoted that the temporary price increase was "what we call a dead cat bounce". After the statement was published, the economy of Malaysia and Singapore continued to fall. But a few years later both economies were fully recovered.
Spotting a dead cat bounce can be very tricky, so here are three steps to identify them:
Identify a stock that is in a strong bearish trend.
Spot signs of rising prices, which break the slope of the downward trend
The price reverses and breaks its last bottom.
As shown within a graph below, we can see the implementation of those three steps. The red line which was explained in step one represents a strong bearish market. The blue line represents signs of small increasing price and the black line represents price reverse.