What is a Dead Cat Bounce?
A dead cat bounce is a temporary recovery from a prolonged decline or a bear market that is followed by the continuation of the downtrend. A dead cat bounce is a small, short-lived recovery in the price of a declining security, such as a stock. Frequently, downtrends are interrupted by brief periods of recovery — or small rallies — where prices temporarily rise. The name "dead cat bounce" is based on the notion that even a dead cat will bounce if it falls far enough and fast enough.
Dead Cat Bounce
- A dead cat bounce is a temporary recovery from a prolonged decline or a bear market that is followed by the continuation of the downtrend.
- It is considered a continuation pattern, where at first the bounce may appear to be a reversal of the prevailing trend, but it is quickly followed by a continuation of the downward price move.
- Dead cat bounce patterns are usually only identified after the fact.
What Does a Dead Cat Bounce Tell You?
A dead cat bounce is a price pattern used by technical analysts. It is considered a continuation pattern, where at first the bounce may appear to be a reversal of the prevailing trend, but it is quickly followed by a continuation of the downward price move. It becomes a dead cat bounce (and not a reversal) after price drops below its prior low. Short-term traders may attempt to profit from the small rally, and traders and investors may try to use the temporary reversal as a good opportunity to initiate a short position.
Frequently, downtrends are interrupted by brief periods of recovery, or small rallies, when prices temporarily rise. This can be a result of traders or investors closing out short positions or buying on the assumption that the security has reached a bottom.
A dead cat bounce is a price pattern that is usually recognized in hindsight. Analysts may attempt to predict that the recovery will be only temporary by using certain technical and fundamental analysis tools. A dead cat bounce can be seen in the broader economy, such as during the depths of a recession, or it can be seen in the price of an individual stock or group of stocks.
Similar to identifying a market peak or trough, recognizing a dead cat bounce ahead of time is fraught with difficulty, even for skilled investors. In March 2009, for example, Nouriel Roubini of New York University referred to the incipient stock market recovery as a dead cat bounce, predicting that the market would reverse course in short order and plummet to new lows. In fact, March 2009 marked the beginning of a protracted bull market, eventually surpassing its pre-recession high.
Example of a Dead Cat Bounce
Let's consider a historical example. Stock prices for Cisco Systems Inc.(NASDAQ: CSCO) peaked at $82 per share in March 2000 before falling to $15.81 in March 2001 amid the dotcom collapse. Cisco saw many dead cat bounces in the ensuing years. The stock recovered to $20.44 by November 2001, only to fall to $10.48 by September 2002. As of June 2016, Cisco traded at $28.47 per share, barely one-third of its peak price during the tech bubble in 2000. By 2019, CSCO shares had reached as high as $47.50.
Limitations of a Dead Cat Bounce
As mentioned above, most of the time, a dead cat bounce can only be identified after the fact, which means that traders that notice a bounce after a steep decline may think it is a dead cat bounce, when in fact it is a trend reversal - that is, instead of being a short-lived bounce, the rally may signal a prolonged upswing. How can investors determine whether a current upward movement is a dead cat bounce or a market reversal? If we could answer this correctly all the time, we'd be able to make a lot of money. The fact is that there is no simple answer to spotting a market bottom.