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Dead Cat Bounce is an Irish comedy band made up of Demian Fox, Shane O'Brien and James Walmsley. Based in Dublin, but touring all over the world, the group perform all-original comedy songs in variety of musical styles.
Dead Cat Bounce
By definition, dead cat bounce is the impermanent recovery in the price of a stock, or a limited time rally once the stock market has faced a significant fall or declining trend.
Dead cat bounce: How does it work?
A dead cat bounce is a short recovery from a downward trending stock. To understand how it works, let’s assume that the stock market is facing a declining trend in the past few weeks, say 10 weeks. In the 11th week, there is a broad market rally. The market rally will be considered as a ‘dead cat bounce’ if it’s short lived, and in week 12 it continues to weaken.
In most cases a dead cat bounce is caused due to the fluctuating market conditions. If the downward trend is for a longer period of time, the investors may interpret that the particular stock/fund/security has waffled. Therefore, they buy more securities than selling, while some call it quits and close out, gaining some profits in a short position. In a nutshell, these factors lead to increase in the buying force.
Generally, a dead cat bounce is used by technical analysts to interpret the price pattern. It is deemed as a continuation pattern. The dead cat bounce may initially appear to be a turnaround of the current trend; however, it is usually followed by the consistency of the declining prices.
Company ABC is trading at $15 per share. After the bell, the company issues a press release stating that their company is restating the earning of the last few years and are under the scrutiny of SEC. The company then opens up next day, trading at $2.20/share. Speculators believe that the company will call it quits, and as a result, now company ABC trades up to $3.20 (note: this is shortly after the opening bell.)
The above scenario is of a dead cat bounce. It is a case of short seller coverings, because there is no key reason as to company ABC trading at $3.20 from $2.20.
How does it matter?
Dead cat bounce is a temporary transition, however it is next to impossible to determine (at the time of dead cat bounce) if the market rally is a source of a constant reversal.