All About Dead Cat Bounce Pattern

Every minute, millions of traders trade securities. Market volatility is a result of constant buying and selling. A trader's most important task is to identify patterns and interpret market movements. Clear patterns can help investors and traders decide the best course of action. Some patterns indicate continuity, while others signal a trend reversal. These patterns are a common basis for traders and investors, particularly short-term. The investing community is familiar with the dead cat bounce. It is easy to grasp the logic behind the dead cat bounce. Although the dead cat bounce pattern sounds simple in theory it can be difficult to recognize in real life.

What's a dead cat bounce?

After a long period of decline in prices, the dead cat bounce is a continuation trend. Most times, prices recover quickly after a prolonged period of decline. Many market participants believe that the recovery is a sign of reversal. The recovery is brief-lived, and prices begin falling again after a short period. After the recovery, the price drops back to its previous lows. The dead cat bounce is the result of a short recovery followed by continued decline. The pattern's name is derived from the fact that even dead cats can bounce after falling for long periods of time.

What causes a dead-cat bounce pattern?

It is essential to understand the definition of dead cat bounce in order to fully comprehend the reasons behind the dead cat bounce. Technical analysts use the dead cat bounce pattern most often. Analysts and traders must be able to identify a dead-cat bounce. They need to know with sufficient certainty whether a rally following a long decline is temporary or permanent. What causes a dead-cat bounce? The price of an asset drops continuously when bears are dominant. But bears can sometimes reevaluate their positions. Some bearish traders make partial profits by clearing short positions after driving the price down for a while. Value investors see the price recovery as a sign that the price is near its bottom and create long positions. As all indicators point to the oversold territory, momentum investors also create long positions. All of these factors create buying pressure that lasts for a brief time, which leads to a dead cat bounce.

How do you trade a dead cat bounce?

Even for experienced investors, a dead cat bounce can be difficult to predict. After a drop of several weeks, or even intraday trades, a dead cat bounce may occur. The security's price should fall at least 5% from its opening price. For volatile stocks, the price must fall by at least 5% in order to be considered for a dead cat bounce pattern. Shorting security is the best way to trade dead cat bounce patterns. The price of a dead-cat bounce pattern will drop steeply before a brief rally. The chances of the price falling again increase when it reaches the opening levels, or the point from which the decline began. The price will begin to fall once it reaches the opening levels. Short positions should be taken as soon as possible. As it signals a dead cat bounce pattern, it is best to sell the security when the price begins falling again. If the price rises, a dead cat bounce might not occur. This could cause losses. It is therefore better to confirm the pattern before you take positions.

Conclusion

Like other technical patterns, it is important to consider other indicators before acting. Dead cat bounce is only visible in hindsight so it is important to be cautious when acting. To limit losses from a misread deadcat bounce pattern, set price targets and use stop-loss.