by Amanda Harvey
A dead cat bounce in stock market terms refers to a small temporary rebound in price of a stock which has been experiencing a sharp decline. This phenomenon takes its name from the concept that even a dead cat will bounce if it falls far and hard enough. The phrase was first introduced in 1985 in an article in the Financial Times, to describe a minor rise following a sharp decline in the Asian markets.
The Dead Cat Bounce as a Chart Pattern
This temporary rebound is sometimes considered to be a continuation chart pattern, meaning that it confirms a continued downward movement after its completion. The movement may initially appear that a reversal is commencing, but after a brief upturn, the price resumes its downward movement. When the price drops below its previous low, the movement may be classed as a dead cat bounce.
What Causes a Dead Cat Bounce?
When a stock is falling dramatically, there are several situations that may occur to create a small but unsustainable rise. The first cause is a burst of insider buying executed by executives within the company in an effort to boost share prices and investor morale. The second is that the company may also receive upgrades from analysts which enhance the perceived viability of its investment potential. Thirdly, the bounce may be triggered by market players buying shares in the belief that the stock price has reached its low point and that the price will subsequently begin rising.
How to Distinguish a Dead Cat Bounce from a Reversal
When a stock which has been moving sharply downward begins to rise, there are a couple of ways to ascertain whether this is the beginning of a reversal, or simply a temporary bounce.
Firstly, an examination of preceding chart patterns can provide insight into the probable nature of the movement. In the example shown below, Keurig Green Mountain Inc is demonstrating a dead-cat bounce. From a technical analysis standpoint, the head and shoulders pattern that preceded the beginning of the decline indicates that the amount and duration of the expected decline is likely to be greater than what was seen prior to the rebound.
Chart by FreeStockCharts.com Copyright©2015 Stock-Options-Made-Easy.com
Using fundamental analysis to assess the conditions within the company can also offer an indication of whether the recovery is likely to be temporary or sustainable. In the case of Keurig Green Mountain Inc, the evidence that the rebound would be temporary can be seen in the fact that the decline in stock prices was in large degree related to difficulties within the company. As well as the disappointing revenue and earnings reports presented on May 7, 2015, which the company blamed on partnership and supply issues, there was also an announcement of possible legal proceedings against the company by its shareholders.
By considering both the preceding chart patterns, and the general status of the company, an investor can make a probable assessment of whether or not the rebounding of a price is a dead-cat bounce.
A temporary upward movement in a stock price which has been declining steeply is often a condition described as a dead-cat bounce. This bounce may provide confirmation that the decline will continue, and as such can be termed a bearish indicator. By using methods of analysis, and investor can ascertain the likelihood of whether the movement is indeed a temporary rebound rather than a reversal.