Dead Cat Bounce

No, I haven’t lost my mind. The phrase “Dead Cat Bounce” is used in the financial industry to describe a particular movement in the markets. Specifically, when the markets have been declining either for a long time, or sharply for a short time, sometimes a temporary recovery with rising prices can occur, only to be followed by further large declines. A dead cat bounce refers to the notion that even a dead cat will bounce if dropped from high enough of a point.

There are a couple of reasons why we see these dead cat bounce occurences.

Programmed Trading

A programmed trade can be as simple as someone having a standing buy order for a stock. For example if company ABC was trading at $60, some investors might say they wouldn’t be interested in owning that stock until the price dropped to $50. Instead of keeping an eye on the stockon a daily basis, they might just tell their broker to put in an order to buy it for $50 and just wait (and hope) it gets filled. Many times, there can be a large number of orders placed for a certain price. If the stock (or market) has been falling fast, then all of these orders can be triggered (and in most cases they then become standing market orders which means they will take the next available price for the stock). Since there can be a flood of buy orders (and not enough sellers), the price can be temporarily bid upwards. Once all the orders are filled, the decline can again resume.

Speculation

Another reason that could explain dead cat bounces is just pure speculation. Back on January 21st, 2008 when the TSX dropped 600 points many people put orders to buy stocks or index funds (or double-exposure index funds) late that afternoon since such a drop was larger than normal or expected. They were rewarded with similarly larger than expected gains. From time to time when these precipitous declines occur and speculators jump in to buy, the buying pressure can temporarily drive prices up – however, a dead cat bounce indicates that the speculators did not time the market bottom well as prices would then continue to decline after this temporary blip.

Preet Banerjee
Preet Banerjee
...is an independent consultant to the financial services industry and a personal finance commentator. You can learn more about Preet at his personal website and you can click here to follow him on Twitter.
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  • TKO from Ontario

    Long term investor here, still sitting on cash.
    Waiting patiently to pounce at:

    TSX @ 12,500
    DJIA @ 11,000
    Nasdaq @ 2,100
    Gold @ 275

    ‘Dead Cat Bounce’ I like, ‘Catching a Falling Knife’ I hate.

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