A dead cat bounce is a period of time in the stock market in which a stock/security that has been on a continual decline makes a more positive return. This period of time is typically a very short one.
For example, if a stock were to be experiencing a hard period of decline in value for 14 weeks, and then suddenly on the 15th week of its expected decline it were to rise back to a more respectable value without prior warning, this would be an example of a dead cat bounce.
Dead cat bounce – not uncommon
The occurrence of a dead cat bounce is not uncommon in the stock market, as stock prices rise and fall all of the time – such is the nature of trading and the stock market – if the demand for a stock rises, it’s value will rise. If the demand for a stock falls, its price will fall alongside its falling demand.
However, any stock that has experienced a fall in value and then a rise is not simply a dead cat bounce. A dead cat bounce refers to a stock that has experienced a constant fall over a considerable period of time that then suddenly recovers. Click here if you would like to know more about the dead cat bounce!
There must have been a long decline
For a bounce in value of a stock to be considered as a dead cat bounce, it must experience a notable, worth change in its value. In simple terms, it is required the closing price of the stock that day is considerably higher than the opening price of the stock. The price must keep declining for a noticeable period of time after the market opens until its recovery for it to be considered a dead cat bounce.
A drop in the value of a stock can be due to a vast number of things, as you can most likely imagine. For example, should a company experience a financial disaster of some sort, or something happens in the world that makes it clear that the company in question is going to be adversely affected in some way or another, this could cause a massive drop in value of their stock.
Although possible, knowing when a dead cat bounce is going to occur can be extremely difficult – for which reason, the occurrence of a dead cat bounce is usually only noticed after it has happened.
Dead cat bounce not always a bad thing
A dead cat bounce is not always a bad trend to have spotted, however, and you can make use of the time if you manage to spot one to either decide what you would like to do with those affected securities that you are holding at the time it occurs, or can buy into the stock that is affected. Ultimately, if you hold any securities that are affected by a dead cat bounce, you will still want to try your absolute best to profit from them.
At the same time, if you are looking at buying into a dead cat bounce, you will want to be able to turn a profit on the securities that you purchase.
Now that you have more knowledge on what a dead cat bounce is and more of an idea on how to identify one – let’s delve into the best ways to go about trading one, and techniques and strategies that you can implement in order to place yourself in the best position of turning a profit after trading on one of these, at first glance, difficult patterns.
Shorting
Once you notice a dead cat bounce starting or one that you think Is just about to start, it is important that you act as quickly as you possibly can should you want your results to be at all desirable. Before we look more closely into this, you should first know what the term “shorting” means when applied to the stock market, and the buying of selling of shares and securities.
Shorting, also referred to as “short selling” is the process of purchasing shares and then selling them within a very short frame of time, often right-away.
The purpose of shorting is to rid oneself of a security that one believes could cause a loss. This can be beneficial if the trader manages to buy securities and sell them, and then buy the same shares again but at a lower price.
You may be confused at this point as to how one would make money doing this. What happens is that the investor, assuming all goes well, will have made money on the previous holding of stocks/shares that they had buy managing to sell them at a better price point than the one at which they bought their current holding for. This can be of course beneficial to them, but is very risky and is not considered a great technique for making profit in the stock market by a number of traders.
Short sell when you spot or sense a dead cat bounce
So, now that you know what shorting is, the start of the dead cat bounce trading pattern should make a bit more sense to you. When you notice a dead cat bounce that is either happening or is about to happen, it is a good idea to short sell the holdings in that stock that you currently have.
If you time this right, as is the nature of short selling, you should be able to make money on this (or at least not lose any), and obtain these same number of stocks/shares but at a lower price. Repeating this process iteratively will make sure that your trading account does not suffer a massive loss in the event that the stock in question plummets massively below the price that you paid for it at first investment. What this process does is essentially eliminate your risk of losing money in the even that one of your stocks continues to lose value.
Before you are able to trade a dead cat bounce effectively and start making profit, you should make sure that you know how to and are able to identify trends in the stock market that could both signify that one is taking place, and even better that one is about to take place. If you are able to identify a dead cat bounce before it happens, you will be in a much better position to plan how you are going to trade it well.