A dead cat bounce is a phenomenon that investors sometimes see in the stock market. It’s essentially a short-term uptick in prices followed by a sharp drop.
Some people believe that this occurs because of emotional trading—investors see the price go up and get excited, only to sell when it drops again. Others think there’s more to it than that.
In this article, we’ll explain everything you need to know about dead cat bounce, including its meaning and history.
- What Is a Dead Cat Bounce?
- What Is the Origin of Dead Cat Bounce?
- How to Spot a Dead Cat Bounce
- Examples of Dead Cat Bounce
- What Causes a Dead Cat Bounce?
- Limitations of the Dead Cat Bounce
- Our Takeaway
What Is a Dead Cat Bounce?
To better understand this concept, it’s vital to define dead cat bounce first. In short, a dead cat bounce is a small and short-lived recovery in the price of a stock after a sharp decline.
The term “dead cat bounce” stems from the idea that even a dead cat will bounce if it falls from a high enough height. Similarly, even a struggling stock can have a brief moment of recovery before continuing its downward trend.
What Is the Origin of Dead Cat Bounce?
Dead cat bounce is not a recent term. In fact, the dead cat bounce origin can be traced back to the 1980s. This expression was coined due to the financial issues faced in the UK.
How to Spot a Dead Cat Bounce
There are a few things you can look for to spot a dead cat bounce. First, there should be a significant decline in prices over a short period of time—days, weeks, or even months. After the initial drop, there will be a small rebound in prices. This is typically followed by another decline, often bigger than the first.
However, it’s important to remember that not all rebounds are dead cat bounces. To be classified as such, the rebound must be small and short-lived.
Examples of Dead Cat Bounce
A dead cat bounce often happens in the stock market. On October 19, 1987, the stock market experienced a sharp decline known as “Black Monday,” when the Dow Jones dropped by 22.6%.
Unfortunately, other industries suffered from dead cat bounce as well. For example, the most recent example of a dead cat bounce was seen in crypto. In November 2018, the world’s largest cryptocurrency price dropped by 37%.
What Causes a Dead Cat Bounce?
There are a few different points that could lead to dead cat bounces. Let’s take a closer look.
Considering that a bull market is on the rise, it’s not a secret that the financial conditions are more favorable. However, this is not the same for bears. When they take control, the stock market’s value falls steadily.
As bears are more skeptical of the stock market, they believe that the values will fall in the future and, as a result, they will most likely change their purchasing habits. This causes the value to rise, leading to a dead cat bounce pattern.
The purchase of long stocks will increase the buying pressure on investors. Following a period of decline, the unexpected surge in sales results in a gain in stock value. This causes a rebound in prices, but it doesn’t last long. As soon as prices start to rise, investors sell, and prices drop again.
Limitations of the Dead Cat Bounce
Unfortunately, the dead cat bounce has some limitations you should be aware of.
Hard to Indicate
It can be difficult to indicate when a dead cat bounce is happening. This is because it often looks like a regular rebound. The only way to know for sure is to wait and see how prices develop over time.
Length of Dead Cat Bounces
The biggest limitation is that there is no set time frame for a dead cat bounce. It can last for days, weeks, or even months. Therefore, it’s difficult to predict dead cat bounces and how long they will last.
As already mentioned, a dead cat bounce is a sudden and temporary recovery of the stock price that has declined in value.
Some people believe that this pattern is actually evidence of market manipulation. Specifically, big players are pushing prices around to make money on unsuspecting investors. Others attribute dead cat bounces to natural investor sentiment. When sellers have already sold their stocks, buyers appear at slightly higher prices and push the market back up briefly.
Whatever the reason, dead cat bounces can be tricky to predict and, therefore, take advantage of. If you’re watching a stock that’s seen a big drop in value, be aware of the possibility of a dead cat bounce, and don’t get caught holding the bag when prices drop again.
Frequently Asked Questions
How long does a dead cat bounce usually last?
As any investor knows, the stock market is a volatile place. Prices can rise and fall rapidly, and it can be difficult to predict how long any given trend will last. However, some investors believe that there is a pattern to the ups and downs of the market, which can be used to make a profit.
One of the most well-known theories is the dead cat bounce. This states that after a stock has experienced a sharp decline, it will often rebound before resuming its downward trend. While there is no guarantee that this pattern will always hold true, many investors watch for signs of a dead cat bounce to buy low and sell high.
What is the opposite of a dead cat bounce?
The opposite of a dead cat bounce would be an inverted dead cat bounce. For example, a company announces a dramatic rise in prices by 5% to 20% or more before a decline. The inverted dead cat bounce is typically tied to earnings or favorable outcomes from dispute resolutions, legal awards, contract wins, etc. When the price increases, it usually drops within a week or two.
Who invented the phrase dead cat bounce?
Now that we know the dead cat bounce meaning, we can talk about the origin of this term. The phrase “dead cat bounce” is thought to have first originated on Wall Street. However, Raymond DeVoe Jr. coined the term in 1985.
The term quickly caught on among investors and has since become a widely recognized market truism. It’s thought to be derived from the notion that even a dead cat will bounce if it falls from a sufficient height.