Trading with the Dead Cat Bounce Pattern
Dead Cat Bounce is one of the most recognized patterns in technical analysis. Read on to find out how the pattern is created, and how to use it to make better trades.
The "dead cat bounce" is a commonly used phrase among traders, often used to describe a short-term recovery in the price of an asset following a sharp decline. The phrase is based on the idea that even a dead cat will bounce if it falls from a great height. The pattern is observed when an asset experiences a rapid drop in price, followed by a temporary rebound before the price continues to decline. This pattern is frequently seen in financial markets and can be both an opportunity and a risk for traders.
TL;DR
- Dead Cat Bounce is a pattern in technical analysis that describes temporal price recovery in a continuing downtrend
- It is quite difficult to spot in real-time and requires the help of fundamental analysis
- Provides an opportunity for opening short-term long or long-term short positions
- The pattern has no fundamental meaning for the asset, it is strictly speculative
The History
In December 1985, during the recession of that year, the Singaporean and Malaysian stock markets experienced a significant decline, followed by a rebound. The London-based Financial Times journalists Chris Sherwell and Wong Sulong referred to this rebound as a "dead cat bounce" in a news citation. Despite the markets' upward trend, both economies continued to experience a decline.
The phrase "dead cat bounce" was later used in reference to falling oil prices the following year, and proposed by Raymond F. DeVoe Jr. to be printed on bumper stickers as a warning. The phrase gained popularity in the 1990s and 2000s.
What does a Dead Cat Bounce look like?
It is not difficult to recognize the Dead Cat Bounce in retrospect, however, in real-time, the recognition is much more challenging and often requires the support of fundamental signals. The pattern itself is characterized by a steep decrease in price, followed by a temporary recovery, which later resumes the decrease.
- Sharp price decrease - temporary increase - continuation of the decrease
- Can be easily mistaken for market recovery or trend reversal
In trading, Dead Cat Bounce is seen as a continuation pattern, meaning after the pattern is finished, the market continues in the same direction.
Notable Examples in Crypto
- Bitcoin's decline from nearly $20,000 to around $6,000 in early 2018 (as seen in the image above), followed by several short-lived price increases, which were later revealed to be dead cat bounces. The price ultimately continued to decline, reaching a low of around $3,200 later that year.
- Another dead cat bounce occurred in mid-2019, when Bitcoin briefly rose to around $14,000 before dropping back down to around $10,000. There was a brief price increase to around $13,000, but the price ultimately continued to decline, reaching a low of around $3,800 in early 2020.
- Ethereum experienced a dead cat bounce in early 2021 after dropping from its ATH (all-time high) of nearly $1,500 to around $800. The price briefly increased to around $1,400, but ultimately continued to decline, reaching a low of around $1,800 in the following months.
- The crypto market as a whole experienced a significant decline in May 2021, with Bitcoin dropping from around $60,000 to around $30,000. There were several short-lived price increases in the following weeks, which were later revealed to be dead cat bounces. The price ultimately continued to decline, reaching a low of around $29,000 later that month.
Fundamental Meaning in crypto?
The pattern really has no fundamental meaning and it is only the result of speculation. Its difficulty to identify may confuse a lot of traders, who rapidly open long positions in the hope of trend reversal. An appropriate thing to do is to always consider broader economic conditions to find out whether the movement could actually be a trend reversal.
Placing trades
It is advised to proceed with caution when trading supposed trend reversals. However, if according to the fundamentals, trend continuation is expected, traders may exploit the Dead Cat Bounce pattern in two ways.
- Opening short-term long positions and exiting before the downtrend continues
- Dead Cat Bounce provides a great opportunity for opening short positions. That is also one of the reasons why this pattern emerges at all.
FAQs
How to spot a Dead Cat Bounce?
The pattern is difficult to spot in the real time. However, it can be easily recognized in the retrospect by looking at the downtrend of a particular asset. If the downtrend was disrupted by smaller upward swings, those are Dead Cat Bounces.
Is Dead Cat Bounce bullish or bearish?
The Dead Cat Bounce is a bearish pattern. It occurs in a downtrend and the pattern tells us that the downtrend is going to continue.
How long does a Dead Cat Bounce last?
A Dead Cat Bounce is a short-lived price increase after a significant decline in price, often lasting only a few days or weeks. The duration of a Dead Cat Bounce can vary depending on various factors such as market sentiment, the severity of the decline, and external events affecting the market. However, it's important to note that the bounce is usually temporary and followed by a continuation of the overall downward trend. Therefore, traders should be cautious when interpreting short-term price increases as a reversal of the trend.
How do you trade a Dead Cat bounce?
Trading a dead cat bounce involves taking a short position, which means selling an asset that you do not own with the hope of buying it back at a lower price. To trade a dead cat bounce in crypto, a trader would typically wait for a short-term price increase following a significant decline in price. Once the price starts to rise, the trader would then sell the asset, hoping to buy it back at a lower price when the price inevitably drops again.
What is the opposite of a Dead Cat Bounce?
The opposite of a Dead Cat Bounce is a "V-Shaped" recovery. In a V-shaped recovery, the price of an asset experiences a sharp decline, followed by a rapid and sustained recovery back to its previous high or higher. This pattern is characterized by a quick rebound and a sharp, upward trajectory, unlike the short-lived recovery seen in a Dead Cat Bounce.
