A dead cat bounce is a pretty morbid way to describe a certain type of market behavior, but it’s gained universal acceptance. So what does this gruesome metaphor describe? When you hear the phrase dead cat bounce, it is referring to a temporary rally of a stock or broader market, after a prolonged downtrend. But why a dead cat bounce? The phrase is meant to say that anything can bounce if it falls fast enough, even a dead cat.
This bounce is quite common in the market. And it has to do with trader sentiment. We’ve been taught over and over to buy the dips. Therefore, once we see an asset that has fallen hard, we assume it’s a good opportunity to buy. While this may work out in the long term, it’s not uncommon for assets to continue to fall following a short reprieve. It may not be the most eloquent way of putting it, but everyone in the stock market knows exactly what a dead cat bounce is.
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How to Spot a Dead Cat Bounce?
Well here is the tricky thing about this. You won’t know it is one until it’s over. This is because they’re nearly impossible to predict. If an asset declines in a short period of time, and then rebounds, we still wouldn’t know if that was a dead cat bounce.
In fact, it doesn’t officially become one until the asset continues to trend lower following that minor rally. If the rally continues, then it wasn’t a dead cat bounce at all.
So in this way, we can determine that a bounce is a backwards looking analysis of a stock’s behavior. Some analysis, like technical analysis, is meant to be predictive of what a stock will do.
A dead cat bounce doesn’t really tell us anything about what the future holds, except that the short-term trend will remain bearish.
Where Did the Phrase Dead Cat Bounce Come From?
The first known usage of the phrase came in the mid-eighties from a couple of journalists from the Financial Times. Horace Brag and Wong Sulong coined the phrase when they were describing the volatility in the Singapore and Malaysian markets. As you would suspect, the markets were in freefall after a recession earlier in 1985. At the end of the year, the markets briefly rallied. However, they continued to fall shortly thereafter.
Dead cat bounce has also been used to describe things like a politician’s approval ratings during an election. Obviously, the most common way of using the phrase is in referring to the financial world. But there are likely other real-world examples where it can be used as well.
How Long Does a Dead Cat Bounce Last?
Another difficult question with almost zero chance of having a correct answer. Theoretically, the continuation of a downtrend for a stock can go to zero. Now, in the case of most stocks and indices like the S&P 500, a fall of that magnitude is extremely unlikely. In fact, if the S&P 500 went to zero, the global economy would likely crumble before our very eyes!
Timing the bottom in any investment is a difficult task. Even if you use things like support levels and trendlines in technical analysis, a stock can break below support at any moment. Technical analysis can provide a prediction of the future based on past behavior and probabilities. But it’s not a hard and true guarantee.
The problem with trying to time a bottom is it could be one of several dead cat bounces in a row. In the long run, it’s a far more sound investment strategy to buy and hold; rather than to time-periodic dips.
When Was the Last Bounce?
Adding further controversy to a dead cat bounce is exactly how people perceive it. The last known one for the S&P 500 was back in March of 2020 at the start of the COVID-19 outbreak. The benchmark index fell by over 30% in the span of days but then recovered by about 17% shortly after.
Some added volatility led to some people believing it was a dead cat bounce. Although we know that following that volatility came a bull run of the likes that the markets hadn’t seen in years.
So was it even a dead cat bounce? It’s difficult to pinpoint exactly when one happens. What could be defined as a bounce for some, might not be for others. For this to be a textbook dead cat bounce, we would have liked to see the S&P 500 continue to tumble.
The quick reversal was tricky for any analyst to predict, but then again this was a unique and potentially once-in-a-lifetime scenario.
Other dead cat bounces appear throughout history; mostly during clear bear markets. Further declines have caused many investors to lose their momentary profits. On the other side of the coin, opportune traders who can quickly scalp that bounce for profits can execute a nice sell-high trade in a short amount of time.
Are There Dead Cat Bounces in Crypto Markets?
Sure! Any efficient market can have a this type of bounce. It doesn’t just have to be the stock market. Crypto markets, real estate markets, foreign exchange markets, any of them can exhibit a dead cat bounce. In recent years, particularly with cryptos like Bitcoin, dead cat bounces have been very common.
This is because in the crypto markets, there is generally believed to be a higher than normal amount of FOMO. Since a lot of crypto investors are retail investors, or at least not whales, any price movement can set off a chain reaction. Crypto investors are famous for buying on big dips. After all, it’s the crypto markets that coined the term to HODL, which is a play on the word hold. But it’s also an acronym for Hold On for Dear Life.
Will There Be Another Dead Cat Bounce Soon?
We’ve already seen some increased volatility due to the ongoing COVID-19 pandemic. Specifically, when there is a rise in cases or new variants, the markets seem to overreact in one direction and then overcompensate back in the other.
We saw this with both the Delta variant and recently with the Omicron variant. The global markets tumbled out of fear. The next session saw a massive rebound as investors around the world bought the temporary dip.
Following that, the markets continued to decline as the spread of the variant weighed heavily on the minds of investors.
But to answer the question, of course we will see another dead cat bounce at some point. Believe it or not, we’re still in a bull market right now, although things are slowing down from last year’s performance. Make no mistake, we will see a bear market again at some point. While most investors don’t want to hear about bear markets, pullbacks and consolidation can be healthy. It’s only a matter of time until we see another dead cat bounce, but of course, we won’t know it until it has already passed.
Why Did They Choose A Cat?
This is unclear, although perhaps we can just assume that Brag and Sulong were dog-lovers? Wouldn’t a dead bear bounce make more sense? Or a dead bull bounce if we are in a bear market. It could be that it is a play on the fact that cats always land on their feet, although adding in the fact that the cat is dead is slightly concerning. Whatever the reason was that the two journalists chose a cat, the phrase has stuck around for nearly forty years now. I’m sure they could have thought of something a little less graphic, but perhaps as journalists they needed to grab the reader’s attention.
Final Thoughts
A dead cat bounce is a common event in the world of investing, and generally occurs during a prolonged decline in an asset. The temporary rebound is when the dead cat bounce happens. For it to be an official dead cat bounce, the asset must continue to decline after the brief rise in its price. Dead cat bounces are a bearish event that can only really be detected after it has already occurred. If the asset does not continue to decline, then we can describe it as having found a bottom. As morbid and bearish a signal as it is, nearly every investor knows exactly what a dead cat bounce is!
