Understanding the Concept of a Dead Cat Bounce
A dead cat bounce is a term used in technical analysis to describe a specific price chart pattern. It typically occurs in assets that are experiencing a long-term downtrend.
The pattern represents a temporary recovery in price, followed by a return to the previous low and a continuation of the downward movement.
Dead cat bounce | Source: Investopedia
Brief Recovery in Declining Markets
Specifically, a dead cat bounce refers to a market behavior where an asset, such as a stock or cryptocurrency, shows a short-lived period of recovery within an overall declining trend.
The term originated from the saying, “even a dead cat will bounce if dropped from a certain height.”
Temporary Price Recovery in Declining Trend
This pattern often occurs when many bearish traders close their short positions or when a similar number of bullish investors believe that the asset has reached its bottom and start opening long positions.
It creates a temporary upward movement in the price.
Temporary Recovery in a Downtrend
It’s important to note that a dead cat bounce is considered a continuation pattern. After the temporary recovery, the price tends to resume its long-term downtrend.
The danger lies in mistaking the temporary bounce for a reversal of the overall trend, leading some traders and investors to go long on the asset only to see it continue to decline.
However, the peak of the dead cat bounce also presents an opportunity for traders to initiate short trades, aiming to profit from the resumption of the asset’s downward movement.
The Role of Market Sentiment
It’s important to remember that these reversals do not reflect the true value of a financial asset but rather reflect the market’s chaotic and ever-changing collective psychology.
Traders should exercise caution and take preventive measures before opening new positions under any circumstances.