A dead cat bounce is a morbid way to describe a certain market behavior, but it’s gained universal acceptance. So, what does this gruesome metaphor describe? Dead cat bounce refers to a temporary stock rally or broader market rally after a prolonged downtrend. But why does a dead cat bounce? The phrase means that anything can bounce if it falls fast enough, even a dead cat.
This bounce is quite common in the market. And it has to do with trader sentiment. We’ve been taught over and over to buy the dips. Therefore, once we see an asset that has fallen hard, we assume it’s a good opportunity to buy. While this may work out in the long term, it’s not uncommon for assets to continue to fall following a short reprieve. It may not be the most eloquent way of putting it, but everyone in the stock market knows exactly what a dead cat bounce is.
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Well, here is the tricky thing about this. You won’t know it is one until it’s over. This is because they’re nearly impossible to predict. If an asset declines quickly and then rebounds, we still wouldn’t know if that was a dead cat bounce.
It doesn’t officially become one until the asset continues to trend lower following that minor rally. If the rally continues, it wasn’t a dead cat bounce.
So, in this way, we can determine that a bounce is a backward-looking analysis of a stock’s behavior. Some analyses, like technical analysis, are meant to predict what a stock will do.
A dead cat bounce doesn’t tell us anything about the future except that the short-term trend will remain bearish.
Dead Cat Bounce History
The first known usage of the phrase came in the mid-eighties from a couple of journalists from the Financial Times. Horace Brag and Wong Sulong coined the phrase when describing the volatility in the Singapore and Malaysian markets.
As you would suspect, the markets were in freefall after a recession earlier in 1985. At the end of the year, the markets briefly rallied. However, they continued to fall shortly after that.
Dead cat bounce also describes a politician’s approval ratings during an election. The most common way of using the phrase is to refer to the financial world. But there are likely other real-world examples where it can also be used.
How Long Does It Last?
Another difficult question with almost zero chance of having a correct answer. Theoretically, a stock’s continuation of a downtrend can go to zero. Now, in the case of most stocks and indices like the S&P 500, a fall of that magnitude is extremely unlikely. If the S&P 500 went to zero, the global economy would likely crumble before our eyes!
Timing the bottom of any investment is a difficult task. Even if you use support levels and trendlines in technical analysis, a stock can break below support at any moment. Technical analysis can predict the future based on past behavior and probabilities. But it’s not a hard and true guarantee.
The problem with trying to time a bottom is it could be one of several dead cat bounces in a row. Buying and holding is a far more sound investment strategy in the long run than time-periodic dips.
Dead Cat Bounce Example
This is a dead cat bounce example of a daily chart of $CGC, Canopy Growth Corporation, a pot stock.
When Was the Last Dead Cat Bounce?
Adding further controversy to a dead cat bounce is how people perceive it. The last known one for the S&P 500 was back in March 2020 at the start of the COVID-19 outbreak. The benchmark index fell by over 30% in days but recovered by about 17% shortly after.
Some added volatility led to some people believing it was a dead cat bounce. However, we know that following that volatility came a bull run of the likes that the markets hadn’t seen in years.
It isn’t easy to pinpoint exactly when one happens. What could be a bounce for some might not be for others. For this to be a textbook dead cat bounce, we would have liked to see the S&P 500 continue to tumble.
The quick reversal was tricky for any analyst to predict, but this was a unique and potentially once-in-a-lifetime scenario.
Other dead cat bounces have appeared throughout history, mostly during clear bear markets. Further declines have caused many investors to lose their momentary profits. Conversely, suitable traders who can quickly scalp that bounce for profits can quickly execute a nice sell-high trade.
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Another Dead Cat Bounce
We’ve already seen some increased volatility due to the ongoing COVID-19 pandemic. Specifically, when there is a rise in cases or new variants, the markets seem to overreact in one direction and then overcompensate back in the other.
We saw this with both the Delta variant and recently with the Omicron variant. The global markets tumbled out of fear. The next session saw a massive rebound as investors worldwide bought the temporary dip.
The markets continued to decline as the variant spread weighed heavily on investors’ minds.
But to answer the question, we will see another dead cat bounce at some point. Believe it or not, we’re still in a bull market, although things are slowing down from last year’s performance. Make no mistake. We will see a bear market again at some point.
While most investors don’t want to hear about bear markets, pullbacks, and consolidation can be healthy. It’s only a matter of time until we see another dead cat bounce, but we won’t know it until it has already passed.
Dead Cats in Crypto Markets
Sure! Any efficient market can have this type of bounce. It doesn’t just have to be the stock market. Crypto, real estate, and foreign exchange markets can exhibit a dead cat bounce. Dead cat bounces have been very common recently, particularly with cryptos like Bitcoin.
This is because there is generally believed to be a higher-than-normal amount of FOMO in the crypto markets. Since many crypto investors are retail investors, or at least not whales, any price movement can trigger a chain reaction. Crypto investors are famous for buying on big dips. After all, the crypto markets coined the term HODL, a play on the word hold. But it’s also an acronym for Hold On for Dear Life.
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Why Did They Choose a Cat?
This is unclear, although perhaps we can assume that Brag and Sulong were dog lovers. Wouldn’t a dead bear bounce make more sense? Or a dead bull bounce if we are in a bear market. It could be that it is a play on the fact that cats always land on their feet, although adding that the cat is dead is slightly concerning.
Whatever the reason the two journalists chose a cat, the phrase has stuck around for nearly forty years. I’m sure they could have thought of something less graphic, but perhaps they needed to grab the reader’s attention as journalists.
Final Thoughts
A dead cat bounce is a common event in investing and generally occurs during a prolonged decline in an asset. The temporary rebound is when the dead cat bounce happens. For the asset to be official, it must continue declining after the brief price rise.
They’re a bearish event that can only be detected after it has occurred. If the asset does not continue to decline, then we can describe it as having found a bottom. As morbid and bearish a signal as it is, nearly every investor knows exactly what a dead cat bounce is!
