WHAT IS 'Cover On A Bounce'

Cover on a bounce is a stock trading term that means to cover a position by trading after the stock price has bounced off a support level. The strategy involves waiting for the stock to go low enough to hit a support level, then bounce briefly, then go slightly lower to correct for the bounce, and closing the short position at this low point. The trader or investor uses the bounce as the indicator that the price will go slightly lower, to correct for the bounce, but not significantly lower. The danger of using this strategy is that it is possible that movement upward after hitting the lower support level could be a full reversal, not simply a predictable bounce. 

BREAKING DOWN 'Cover On A Bounce'

Cover on a bounce means to close a short position by buying a stock after the price falls enough to hit  a level of support, then bounce up briefly, and then correct. This is a trading strategy that uses the bounce to indicate that the stock has stopped falling, which allows the investor or trader to close their short position at the lowest, or close to lowest, price they can.

A level of support is the lowest price a stock has traditionally hit, which means the stock is unlikely to go below that price. A trader or investor could simply wait until the price falls to that support level and then buy to close the short position. However, if the support level fails to hold and the price goes even lower, that can cause momentum and the price will drop much more significantly, and the trader or investor should wait to close the position. There is no way to know if the support level will hold until it either does or doesn't. This means that a bounce up off the support level is the sign that the level of support will hold, so the bounce is the best indicator to the investor or trader that this is the lowest price they will get. As soon as the price corrects from the bounce, the trader or investor will close the position.

An Example

A stock might start at $90 per share, and begin to fall. As soon as the trader or investor uses indicators to conclude that the stock is in a bear trend and will continue to fall, they will open a short position by selling. In this case, they may sell at $80. The stock will continue to fall, until it hits a level of support at $48. The stock has gone to this price before, but hasn't gone lower in over a year. The trader or investor waits to see if the stock will break through and go lower, or if it will hold at the support level of $48. If the stock bounces up to $53, the trader or investor knows that the support level is likely to hold. They wait for the price to correct for the bounce back down to $49, and buy to close the short position. The raw profit on this trade is $31 per share.

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