A dead cat bounce is an investment term in which the price of a stock or other asset temporarily rises during a prolonged period of decline. The painful term comes from the idea that even a dead cat will jump if it falls enough.
Dead Cat Bounce on
Investments is a Sucker Rally. This can encourage investors to invest in troubled companies.
Technically a dead cat jump can only be identified after it has occurred. A bounce is a short-term price increase followed by a decline. A second drop pushes the stock to a new low. Until the second drop, there’s no way to know if the stock rally is a dead cat bounce or the start of truly sustainable stock recovery.
What is Dead Cat bounce?
Simply put, a dead cat bounce is a sharp decline followed by a rally failure and further declines.1 As with all chart patterns, the exact parameters of a dead cat bounce require interpretation. However, there are four main features to keep in mind as you learn the best way to determine your own dead cat rebound.
What does bouncing of a dead cat mean?
The purpose of identifying a dead cat bounce is to determine whether a stock or other asset that has gained in value after a prolonged decline will continue to rise in value. If a trader shorts a particular stock and considers the price rise to be a dead cat rebound, he may decide to hold the short position. Conversely, if a trader sees the price movement as a sustained rally, he should close the short position.
Obviously, “dead cat bounce” is a term commonly used for technical analysis of non-fan stocks. Understanding the basics of a business rather than reading a stock chart is usually the best way to make a profit over the market over time.
However, it is still important to know some key concepts used by technical analysts. It can be useful to consider whether undervalued stocks are rising because the company is doing well, or whether they are getting attention simply because the stock looks cheap after a long decline.
Example of a dead cat bounce
Consider the stock of major financial institution Wells Fargo (NYSE: WFC), which traded at around $53 per share at the beginning of 2020. As the COVID-19 pandemic hit, concerns about loan defaults and falling consumer interest rates drove the bank’s stock price down. important value. By early April, the stock had fallen to around $26.
However, in a matter of weeks from the low, Wells Fargo’s share price rose to $33.91. However, in mid-May, it fell to around $22.50. The temporary price increase appears to be due to the first stimulus package from the federal government. At that time, there was considerable uncertainty about the future of the banking industry.
Investor confidence was low, and the price rally was just a dead cat run. It’s worth noting that Wells Fargo eventually rebounded, but only a few months after the initial rally.
Limitations in identifying a dead cat bounce
As previously noted, the biggest challenge of trying to identify a dead cat bounce is that it cannot be reliably done until it has already occurred. As an example, after the S&P 500 (SNPINDEX:^GSPC) declined sharply in March 2020 due to the pandemic and then started to reverse course, many analysts initially considered the rally to be a dead cat bounce. With the value of the S&P 500 increasing dramatically since that time, it`s clear — in hindsight — that those analysts were wrong.
If the technical stock analysis was reliably correct, then it would be easy to get rich by putting money into the stock market. Correctly identifying a stock price’s low point or the start of a price rally is tantamount to attempting to time the market. Investors are much better served by buying and holding the stocks of quality companies in order to sustainably build their wealth.