What is a Dead Cat Bounce?

A trading term called a dead cat bounce is used for when a stock is in a sharp decline and has a sharp bounce off the bottom levels. It occurs because of the huge short interest in the market. Once supply and demand become imbalanced, any type of rally in the bear market will create a massive short covering that will lead to a rapid price increase. This bounce will be short-lived and followed up by heavy selling that will break the previous low price. A trader will use a bottom-up approach when selecting the best candidate to take a long position, as the investor will be quite intimate with the company’s financials and management structure. The origin of the dead cat-bounce phrasecomes from the East. The first time this phrase occurred was in 1985 when the Singaporean and Malaysian markets bounced after a very strong bear market plunged. A journalist Christopher Sherwell of the Financial Times reported that a stockbroker referred to the rally as a “dead cat-bounce”. You have to be an experienced trader to trade a dead cat-bounce. The first challenge is that the stock is often a falling knife, so deciding where to pick up some shares is to some extent a gamble. The best approach is to wait until there is an explosive move in volume, followed by a reversal pattern for the candlestick. Then take the long position, don’t go crazy. Be prepared to sell out at the first indication of weakness as the move up will be short lived.

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