What does ‘dead cat bounce’ mean?

By September 14, 2022September 15th, 20223 minute read

Even though it is notoriously known for being highly volatile, the crypto market has garnered enormous attention from millions of traders. Recognizing patterns and making sense of market movements are a few of the major skills required to be a seasoned trader. Finding distinct patterns in the market movements aids traders and investors in choosing their next move. In addition, these patterns provide the foundation for the functioning of short-term investors. A common phenomenon identified by investors is the dead cat bounce pattern. The pattern has a straightforward explanation that makes it simple to comprehend. However, it is difficult to identify the dead cat bounce pattern in practical scenarios.

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What is a dead cat bounce?

A dead cat bounce is a technical analysis price chart pattern. It occurs in long-term downtrend assets and denotes a brief uptick in price, followed by a drop back to the previous low and further decline.

A stock, crypto, or any other asset that exhibits short-term recovery during a deteriorating trend is more precisely described as a dead cat bounce. After a significant correction or downward movement, an asset may experience a brief upward surge. The famous phrase “even a dead cat will bounce if dropped at a certain height” is where the term first appeared.

A dead cat bounce pattern may be mistaken for a general trend reversal in its early stages. After some time, though, the price stalls, and the downward trend persists, shattering earlier support levels and setting new lows. As a result, the pattern may also lead to a bull trap, in which investors establish long positions in anticipation of a trend reversal that never materializes.

What does it indicate?

The purpose of trying to spot a dead cat bounce is to ascertain whether a stock or other asset that appreciates after a protracted downturn will continue to appreciate in value. For instance, the decision to keep the short position might be made by a trader who has sold a particular stock short and believes that a price increase is a dead cat bounce. On the other hand, a trader should cut their losses if they believe a price movement to be a long-term rally.

How to understand whether the dead cat bounced?

Although several technical and fundamental analysis techniques can help in trying to forecast whether the rebound is just short or not, doing so is a complex process with unreliable results. Hence, it cannot be stated certainly until the period is over.

A dead cat bounce could result from several factors, including the closing of short positions by bears or the establishment of new long positions by bulls who believe that an asset has already bottomed. Additionally, momentum traders have been known to build up positions as soon as they notice an asset’s relative strength index is oversold.

As aforementioned, a dead cat bounce is typically only discovered after it has occurred. As a result, traders who see a rebound following a sharp collapse can mistake it for a dead cat bounce as a trend reversal indicating a long upswing.

It can be challenging to tell if a recent upward trend is a dead cat bounce or a market reversal. The truth is that identifying a market when it’s at the bottom is not an easy task.

Curtain Thoughts

A wave of relief following a market bounce may lead investors to believe that the winter is in the past now. However, it might simply be a dead cat bounce, a brief bull run during a longer-term bad market. Losses may result for those caught up in a dead cat bounce because it is challenging and dangerous to predict market bottoms. The same goes for other technical patterns; one shouldn’t take action until after considering other indications. When making a decision during the dead cat bounce, caution must be employed because the actual scenario of the market is only apparent after the period. 

Disclaimer: Cryptocurrency is not a legal tender and is currently unregulated. Kindly ensure that you undertake sufficient risk assessment when trading cryptocurrencies as they are often subject to high price volatility. The information provided in this section doesn't represent any investment advice or WazirX's official position. WazirX reserves the right in its sole discretion to amend or change this blog post at any time and for any reasons without prior notice.
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