What Is A Dead Cat Bounce?
It’s probably not what you’re thinking. A dead cat bounce is a short-lived recovery in the price of a declining security (stock, bond, commodity) that’s expected to fall right back down. It’s called a dead cat bounce because even a dead cat will bounce if it falls far enough! The term is thought to have originated on Wall Street and been popularized by British fund manager Alex Thorndike.
Why Do They Happen?
The reason for this is that sometimes when a stock experiences a big drop, people will sell off their shares because they’re afraid of losing out on more money if the price keeps falling. But even if they sell their shares low enough, if everyone else does the same thing and sells theirs too, then there won’t be any buyers left for all those now-cheap stocks! So what happens? They crash back down again! It may be a sign that the underlying fundamentals are poor, such as when increased optimism or productivity fails to boost profits amidst economic headwinds.
So if you’ve been waiting for your favorite company to bounce back up after its latest earnings report or something else bad happened to it, don’t hold your breath too long—it might just be another dead cat bounce!
How To Spot A Dead Cat Bounce
Identifying a dead cat bounce is, in many ways, like recognizing a Martian reindeer. The former is an economic principle, while the latter isn’t (yet). But both are rare sightings that can be spotted if you know what to look for.
There are three key factors that indicate an asset has entered its final death throes:
- It’s had a significant downtrend over time
- It’s undergone a sharp decline
- There’s been a sudden reversal in direction
When Is A Dead Cat Bounce Not A Dead Cat Bounce?
All of these factors being present can make it difficult to differentiate a dead cat bounce from a genuine rally over the long term. In fact, if you happen to be in a position where you are able to sell your stock before a potential dead cat bounce occurs, this may be the best course of action. So how do you tell the difference?
It’s important to remember that, even if a stock is fundamentally sound and has a proven track record of bouncing back quickly after falling, that does not necessarily mean it will always do so.
In order to qualify as a true dead cat bounce, the stock has to drop significantly—at least 20%. Even then, this bounce only lasts for about three days. In other words, if you see your stock go up by 5%, you’re probably looking at a false alarm.
So when is a dead cat bounce not actually a dead cat bounce? When it doesn’t happen in three days!
Sometimes you can make money from dead cat bounces.
As an investor you can take advantage of these temporary blips in prices to make money—assuming you know how to place your bets correctly. If you do, you can buy at the bottom and sell when prices rebound for a nice profit on your investment. One example would be buying Bitcoin at $3k and selling at $13k—you made money on your investment but then got out before things started falling apart again.
However, there are some instances where the price of an asset does rise after a sharp drop but then continues to rise. This is known as “getting the second floor.” This can happen for a variety of reasons: for example, if there’s been bad news about an asset, but the market decides not to believe it or it doesn’t apply to everyone.