A temporary recovery in prices after a prolonged decrease.
What Is a Dead Cat Bounce?
A dead cat bounce is a price chart pattern in technical analysis. It occurs in assets that are in a long-term downtrend and represents a brief recovery, which is then followed by a return to the previous low and continued downward movement.A dead cat bounce is more specifically a market pattern or behavior of a stock, cryptocurrency or any other asset that shows short-term recovery amidst a declining trend. It may be a short-lived upward movement of an asset after a major correction or downward movement. The term originated from the saying that “even a dead cat will bounce if dropped at a certain height.”They may take place when a large enough number of bearish traders close their previously initiated short deals or when a similarly significant number of bullish investors believe that an asset has bottomed out and start opening long trades in it.
A dead cat bounce is a continuation pattern, i.e. after it takes place, the price continues moving in its prevailing long-term direction. The danger of this pattern is that it may at first appear as a reversal of the overall trend of an asset, leading bullish traders and investors to go long on it only for the price to continue falling afterward.
However, the peak of this phenomenon also presents an opportunity for traders to initiate short trades with the intention of taking profit when the asset resumes its fall.
While there are some methods of technical and fundamental analysis that allow trying to predict that the recovery is only temporary, it is a complex task with unreliable results. As such, they can only be definitively called after they have taken their course.
There are multiple variables that could point to the cause of a dead cat bounce, such as when bears start closing their short positions, or when bulls start opening new long positions believing that an asset has already bottomed. There are also instances when momentum traders start stacking positions as soon as they see an asset’s relative strength index at oversold levels.
Unfortunately, many novice traders, especially in the crypto space, fall prey to dead cat bounces as they believe that the assets they buy are on their way to recovery. This is exacerbated by the crypto industry’s lack of regulation, which helps facilitate shady activities like front-running and price manipulation.
Therefore, it is important for analysts to observe the market further whenever an asset suddenly moves in an upward trend after a continuous decline since it doesn’t always indicate a bullish reversal, but could also be a dead cat bounce, which likely won’t recover to previous highs for a while.
It is always necessary to remember that these reversals aren’t actually reflective of the actual value of any financial asset but a reflection of the market’s collective psychology, which is chaotic and ever-changing. Precautionary measures should be observed before traders open new positions under any circumstances.