What Is a Dead Cat Bounce?

What the heck is a dead cat bounce … other than a morbid band name? (Sorry, music fans, that’s just not my beat.)

I’m talking, of course, about the dead cat bounce in relation to the stock market. It’s a stock chart pattern that can occur with some downward trending stocks.

Market downtrends aren’t great. But here’s the thing … The dead cat bounce isn’t all bad, even if the name’s a bit grim.

Today, I’ll give you the lowdown on the dead cat bounce pattern — what it is, how to spot it, and how you can use it.

Thinking about joining my Trading Challenge? Consider this a free lesson. And the more you know about chart patterns, the better you can use them in your trades. Let’s do this!

The Dead Cat Bounce Pattern: An Overview

Such a macabre name … so no big surprise that a dead cat bounce relates to a big drop in a stock’s price. But it’s more than just a general downward trend.

First, the stock’s price falls substantially. Next, there’s a short recovery (hence, ‘bounce’) before it descends again. That’s the dead cat bounce.

The term for this pattern comes from the adage “even a dead cat will bounce,” which became popular in the 1980s. During that time, the Asian markets took a major tumble, then had a brief recovery before falling again.

The name was so memorable, it stuck. Now, the dead cat bounce describes any similar pattern in stocks, commodities, and forex.

Trading and the Dead Cat Bounce Pattern

The dead cat bounce sounds depressing, right? Downward trends can be BLEAK.

But this pattern can come with benefits. Let’s check out some of the pros:

Volatility: Volatility can be a trader’s ally, creating spikes that when traded well can let you ride the momentum. The dead cat bounce comes with a short-term spike — and it can be big.

Buy low: Buying low is typically a trader’s priority. During a dead cat bounce, you might grab shares during the first downward trend to sell during the bounce. But you gotta be spot on. Is it a bounce or is the trend reversing?

Spot market weakness: This pattern can showcase a possible market weakness, whether it’s in the overall market or a specific sector. Knowledge is power for traders … Learn to use a dead cat bounce as an indicator and adjust your strategy accordingly.

Short sellers’ playground: If you run the technical analysis, and you’re confident the stock’s in the middle of a dead cat bounce, the time may be right for short selling — IF the price drops again.

History often repeats itself: This isn’t always the case, but sometimes a dead cat bounce repeats. Some stocks may even cycle through it on a somewhat regular basis. So you might find a pattern … Consider whether another bounce is on the horizon. If so, how will you prep for it?

The Causes of a Dead Cat Bounce

So, now you know what a dead cat bounce is and how you can use it. That’s a great start, but it’s only part of the picture.

Knowing what can cause a dead cat bounce is key. And understanding how it typically plays out is also critical. So let’s step through it…

Say there’s a stock that’s been declining slowly but steadily for several weeks. Now, think like a short trader with a position in that stock. You might wonder if you should exit now and take profits. Logical enough, right?

Now put yourself on the other side. Maybe you’re looking for a trading bargain. This stock is declining but could recover. So you consider buying it. And you wouldn’t be alone.

Let’s say you and a slew of traders decide it’s wise to buy. There’s a flurry of activity, and the stock price moves up in response.

But the frenzy isn’t sustainable. Once the bargain evaporates, buying slows. Short traders may not make profits, so they don’t sell unless they have too.

So … the spike passes. And the downward trend takes over again.

Why does this happen? You can thank (or blame) uncertainty. During the first downward shift, some traders assume that a particular point is the bottom. They make buying and selling decisions based on that notion.

That’s where we get the spike, but that doesn’t mean the company is in the clear.

Remember the dot-com crash of the early 2000s? People thought the first dip was the bottom. And they were horribly wrong. The rally didn’t last, and stock prices tumbled again.

More often than not, extreme and abrupt stock price spikes won’t last. There are very few exceptions. Even a news catalyst isn’t always enough to reverse a trend.

Want an example?

Take the case of Achieve Life Sciences Inc. (ACHV), a company that makes smoking cessation medications. When news of a positive clinical study broke in 2018, share prices soared. But it didn’t last. ACHV went back into decline, with multiple bounces on the way down.

Tips for Trading Using the Dead Cat Bounce

Alright, now you better understand the what, the why, and the how of the dead cat bounce. Now it’s time for some trading tips. The dead cat bounce is a tricky beast, and you want to have a solid trading plan and the right mindset when approaching it.

Let’s dig in…

First, you always (always!) need to use a stop loss. Dead cat bounces can move shockingly fast. If you’re a short trader, a stop loss order can help protect you. You might not know if it’s a bounce or trend reversal until it’s too late to act.

Think and act like a smart, prepared trader: Set up your stop loss ahead of time.

Next, be fully aware of the risk. These patterns come with a lot of uncertainty, and the rapid pace can make them especially risky for traders.

Yes, it’s technically a pattern, but that doesn’t mean you can predict the outcome. No one can. Don’t trade too big.

Finally, knowledge is a powerful tool. Work to improve your stock market knowledge and learn different patterns, even the dead cat bounce. Just because you know ‘em doesn’t mean you gotta trade ‘em. Some trading strategies just won’t suit you, but having the knowledge won’t hurt you.

The Trading Challenge

Ready to improve your trading prowess? Join my Trading Challenge!

I don’t care how experienced you are. I care about how dedicated you are to honing your skills.

I want you to learn to face the markets on your own, then continue to grow, change, and adapt as a trader.

I also invite you to learn from my successes and my mistakes. No trader has a perfect record (if they say they do, they’re lying!), and I’m no exception. Full transparency here

I won’t tell you what to trade, but I’ll teach you everything I know about the markets with plenty of tools and resources. Ask questions. Stay curious. And above all, never stop learning.

How do you feel about trading the dead cat bounce? When’s the first time you spotted this pattern? I’d love to hear your experiences the comments below!