Dead Cat Bounce: A Complete Guide

The idea of a “dead cat bounce” might sound somewhat alarming, but as long as you hear it mentioned within the context of trading, it refers to a particular phenomenon in the stock market. 

What is a Dead Cat Bounce?

When a stock price decreases, it rarely just hurls straight down without experiencing a few peaks along the way. One extreme example of this is the dead cat bounce: when a stock price decreases, it may seem to undergo a slight recovery before returning to its previous low. 

What are the Causes?

A bounce happens when pessimism begins to set into a bear market. If the market continuously displays a downward trend for weeks on end, the conditions for a bounce begin to foster — and it’s made possible by the way different types of traders act. 

The Economics at Play

As you’re probably well aware, the two main forces at play in economics are supply and demand In the case of a bounce, the supply force is made up of the investors who are shorting, while investors drive demand because they believe the stock price is about to increase.

Greedy traders don’t want to pat themselves on the back and bow out when a stock they traded at the bottom increases in value by 10% — or even 20%. So they hold for too long and end up making a loss. 

The Market Psychology

Talking in theoretical terms is all well and good, but to understand how to trade these things, you must be able to recognize patterns.

Real-World Examples

- The Great Depression - The S&P 500 in 1974 - The NASDAQ in 2000

They say that you can’t understand the future if you can’t understand the past, so here are three real-world examples. 

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