What is a dead cat bounce?

'Dead cat bounce' is arguably one of the more colourful financial phrases you'll come across. So what does it mean, and how do you spot one?

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What does the phrase 'dead cat bounce' mean? 

A dead cat bounce is financial lingo used to describe a brief and temporary recovery in the price of an asset, such as a share or cryptocurrency, after a significant and prolonged decline. It implies that even a dead cat will bounce if it falls from a great enough height.

The dead cat bounce typically occurs when investors or traders who have bet against the asset, known as short sellers, begin to buy the asset to cover their positions, which creates a temporary uptick in the price. However, this bounce is usually short-lived, and the asset's price will eventually resume its downward trend, often at an even faster pace.

Dead cat bounces are considered a bear market indicator, suggesting that the overall trend is still downward and that any upward movement is likely to be a false rally. Investors considering buying into an asset during a dead cat bounce should be cautious and research carefully to avoid losses.

What is the origin of this phrase? 

There are a few different stories about the origins of this phrase. One story suggests it originated on Wall Street in the 1980s. 

According to this story, traders would use the phrase to describe the temporary rise in the price of a stock that had experienced a significant decline, comparing the short-lived recovery to how a dead cat would bounce if it fell from a tall building. 

Regardless of its origin, 'dead cat bounce' is now a common phrase used in financial circles to describe a temporary and often misleading recovery in the price of an asset.

What sparks this phenomenon? 

A dead cat bounce is typically caused by a combination of short-term market sentiment and technical factors rather than fundamental factors. 

Some possible causes of a dead cat bounce include:

Short sellers covering their positions: When a stock or other asset experiences a significant decline, short sellers who bet against the asset might buy the asset to cover their positions, creating a temporary uptick in the price.

Speculative buying by traders: Traders might also buy an asset during a decline in the hope of profiting from a brief rebound, which can contribute to a dead cat bounce.

Oversold conditions: When an asset is oversold, meaning that its price has declined rapidly and the asset is perceived to be undervalued, buyers may step in to take advantage of the low price, leading to a temporary rebound in the price.

Shifts in market sentiment: A change in the overall market sentiment, such as a shift from negative to positive sentiment, can also contribute to a dead cat bounce.

It's important to note that while a dead cat bounce may provide a temporary opportunity for traders to profit, it's typically not a reliable indicator of long-term market trends. Investors should carefully consider the underlying fundamentals of an asset before making any investment decisions.

Some prominent examples…  

Some well-known examples of dead cat bounces include: 

Lehman Brothers: In 2008, Lehman Brothers, a global financial services firm, filed for bankruptcy, one of the primary triggers of the global financial crisis (GFC). The stock price had declined sharply in the months leading up to the bankruptcy.

There were a few occasions when the stock price would temporarily rebound, but these were dead cat bounces, and the stock ultimately became worthless.

BlackBerry Ltd: In 2008, BlackBerry was a dominant force in the smartphone market, but the company failed to keep up with the changing market and was surpassed by rivals like Apple and Samsung. The stock price declined sharply in the following years, and there were several dead cat bounces along the way. 

Despite attempts to reinvent itself, the company has never regained its former glory, and the stock price remains far below its all-time high.

Bitcoin: In late 2017, the price of Bitcoin surged to record highs before experiencing a sharp decline in early 2018. The price of Bitcoin rebounded briefly in the following months, only to continue its decline. 

Despite resurging to new heights in September 2020, the cryptocurrency has been dogged by volatility in the ensuing years.

How long does a dead cat bounce last? 

The duration of a dead cat bounce can vary, but it's typically a short-lived phenomenon that lasts a few days to a few weeks at most. The rebound is often brief and temporary, driven by short-term factors rather than fundamental ones. Once the buying pressure subsides, the asset's price will likely resume its downward trend.

The duration of a dead cat bounce may also depend on the volatility of the asset's decline and the overall market conditions. The rebound may be more pronounced but shorter-lived if the slide is particularly sharp and sudden. 

On the other hand, if the decline is more gradual, the dead cat bounce may be less pronounced, but the downtrend could last longer.

How to spot one

Spotting a dead cat bounce can be challenging, but there are a few indicators that investors and traders can look for. These include: 

  • Significant and prolonged declines in an asset's price: Before a dead cat bounce occurs, the asset must have experienced a significant and sustained reduction in price.
  • Sudden and sharp rebound in the asset's price: A dead cat bounce is characterised by a temporary and often sharp rebound in the price of the asset after a prolonged decline.
  • Lack of fundamental support for the rebound: The rebound in the asset's price during a dead cat bounce is typically not supported by strong fundamental factors, such as positive news or financial performance. Instead, it's often driven by short-term or technical factors, such as oversold conditions or a shift in market sentiment.
  • Low trading volume during the rebound: During a dead cat bounce, the trading volume may be lower than usual, indicating that the rebound is driven by short-term traders rather than long-term investors.
  • Reversal of the rebound: After a dead cat bounce, the price of the asset is likely to resume its downward trend, often at an even faster pace.

It's important to note that these indicators are not foolproof, and there is always a risk of misinterpreting market signals. 

What is the opposite of a dead cat bounce? 

The opposite of a dead cat bounce is a sustained recovery or rally in the price of an asset after a period of decline. Strong fundamental factors, such as positive news or financial performance, and a shift in market sentiment typically drive this sustained recovery.

Unlike a dead cat bounce, a sustained recovery is not a brief and temporary rebound in the asset's price but rather a prolonged and consistent increase in its value over time. 

This can give investors a more reliable indication of a long-term uptrend in the asset's price and may present investment opportunities for those looking to capitalise on the asset's improving fundamentals.

Sustained recoveries can take time to develop, and investors should be cautious of making hasty investment decisions based on short-term market fluctuations. 

Instead, it's essential to carefully analyse the underlying fundamentals of the asset and consider a range of indicators to assess the potential for sustained growth.

This article contains general educational content only and does not take into account your personal financial situation. Before investing, your individual circumstances should be considered, and you may need to seek independent financial advice.

To the best of our knowledge, all information in this article is accurate as of time of posting. In our educational articles, a 'top share' is always defined by the largest market cap at the time of last update. On this page, neither the author nor The Motley Fool have chosen a 'top share' by personal opinion.

As always, remember that when investing, the value of your investment may rise or fall, and your capital is at risk.

The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.