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How to Identify a Dead Cat Bounce

February 22, 2021 · 4 minute read

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How to Identify a Dead Cat Bounce

A “dead cat bounce” is a particularly colorful way of describing a sudden, seemingly inexplicable swing in momentum within a specific asset or market. One recent example took place during the 2008 financial crisis (and subsequent stock market crash). For months, investors sat on pins and needles, eager for the market to recover—and experienced a glimmer of hope when the Dow Jones saw an upswing in prices mid-year. Some investors trusted this was the market recovering and jumped on the opportunity to buy shares. Unfortunately, it was only a dead cat bounce created by the false demand of the assets.

In truth, prices continued to plunge until early 2009—when the market finally saw its lowest point. Thus, investors who purchased securities during the growth blip probably didn’t see the profitability they were hoping for.

Unless investors are intentionally engaging in trend trading, being able to differentiate apparent trends like a dead cat bounce from actual market data may help in making more well-informed investment decisions.

What is a Dead Cat Bounce?

When a single security or entire market temporarily recovers after a slow and steady decline—and then continues its drop—it’s known as a dead cat bounce. This rebound doesn’t have a rhyme or reason to the recovery; it’s merely part of a short-term market variation.

In actuality, the rebound creates false value, and investors shouldn’t assume that the asset has actually gained any real value. The term “dead cat bounce” is market jargon that comes from the idea that if you drop a cat from a high enough platform and it falls fast enough, it will bounce.

For this term to apply, the security price must steadily decline in value and then have a short recovery surge. The term won’t apply to a security that’s continuing to grow in value. The revival must be brief, before the price continues to drop again.

A dead cat bounce is not used to describe the ups and downs of a typical trading day—it refers to a longer-term drop, rebound, and continued drop. It’s also important to point out that this financial phenomenon can pertain to individual securities such as stocks or bonds, to stock trading as a whole, or to a market.

Example of a Dead Cat Bounce

To illustrate a dead cat bounce, let’s suppose company ABC trades for $70 on June 5th, then drops in value to $50 per share over the next four months. Between Oct 7th and Oct 14th, the price rises to $65 per share—but then starts to rapidly decline again on Oct 15th. Finally, ABC’s stock price settles at $30 per share.

This pattern is how a dead cat bounce would look in a real-life trading situation. The security quickly paused the decline for a swift revival, but the price recovery was temporary before it started falling again and eventually steadied at a lower price.

How to Spot A Dead Cat Bounce

Because a dead cat bounce is often an illusion of actual intrinsic value, investors may be tempted to jump on an investment opportunity before it makes sense to do so.

The following typical sequence of events may help an investor correctly identify a dead cat bounce.

1. A security’s price steadily declines.
2. The price sees a monetary gain for a short time.
3. A security’s price begins to regress again, dropping lower than the previous low price.

Unfortunately, these characteristics make it easy to mistake a dead cat drop for an investment opportunity. The truth is, there is no exact way to differentiate a dead cat bounce from a full market recovery. It’s generally easier to identify this pattern after the fact, instead of when it’s happening in real-time.

Dead Cat Bounce or Rally?

One way to stay alert for a dead cat bounce with a particular stock is to consider whether the now-rising stock is still as weak as it was when its price was falling. If there’s no market indicator as to why the stock is rebounding, it might make sense to suspect a dead cat bounce.

Dead Cat Bounce or Lowest Price?

Since investors are looking for opportunities to profit, they try to find investment opportunities that allow them to “buy low and sell high.” By using such strategies, they can profit from their investment endeavors. Therefore, when assessing investment opportunities, a successful investor will have to recognize emerging companies and buy shares of their stock before other investors get wind of the lucrative company.

Since companies go through business cycles where stock prices may fluctuate, pinpointing the lowest price point might be hard to decipher. There’s no way to know if a dead cat bounce is happening, until the prices have resumed their descent.

Dead Cat Bounce or Bottom of Bear Market?

Investors may also confuse a dead cat bounce for the bottom of a bear market. It’s not uncommon for stocks to significantly rebound after the bear market hits bottom. According to Market Watch , history shows that the S&P 500 saw substantial gains within the first few months of hitting bottom after a bear market.

Investing Strategies to Avoid a Dead Cat Bounce

For investors who want a more hands-on investing approach, it’s generally better to use investing fundamentals to evaluate a security instead of attempting to time the market (and risk mistaking a dead cat bounce for an opportunity).

Investors who are just starting may want to consider building a portfolio of a dozen or so securities. Picking a few stocks allows investors to monitor performance while giving their portfolio a little diversification. This means the investor distributes their money across several different types of securities instead of investing all of their money in one security, which in turn helps to minimize risk.

Active investors could also consider selecting stocks across varying sectors to give their portfolio even more diversification instead of narrowing their niche. Investors with restricted funds might consider investing in just a few stocks while offsetting risk by investing in mutual funds or exchange-traded funds (ETFs).

For investors who would prefer not to execute an active investing strategy alone, they can speak with a professional manager. Working with a professional manager may help the investors better navigate the intricacies of various market cycles.

The Takeaway

A dead cat bounce is most easily identified after the fact. With a 20-20 perspective, investors and analysts can clearly see that an individual security or market has experienced a steady drop in value, a brief rebound, and then a further steady drop.

For investors who want to take an active role in investing—regardless of potential dead cat bounces—an online trading platform like SoFi Invest® offers the opportunity to manage your money the way you want. You can trade stocks you’re familiar with or explore different investment opportunities.

For investors who’d rather put their investing on autopilot, so to speak, SoFi Invest automated investing might be appealing. You can rebalance your portfolio quarterly to ensure it continues to align with your financial goals and risk profile.

Find out how SoFi Invest can help you reach your financial goals.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
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