In finance, a dead cat bounce is a small, brief recovery in the price of a declining stock. [1] Derived from the idea that "even a dead cat will bounce if it falls from a great height", [2] the phrase is also popularly applied to any case where a subject experiences a brief resurgence during or following a severe decline. This may also be known as a "sucker rally". [3]
The earliest citation of the phrase in the news media dates to December 1985 when the Singaporean and Malaysian stock markets bounced back after a hard fall during the recession of that year. Journalists Chris Sherwell and Wong Sulong of the London-based Financial Times were quoted as saying the market rise was "what we call a dead cat bounce". [4] Both the Singaporean and Malaysian economies continued to fall [5] [6] after the quote, although both economies recovered in the following years.
The phrase was used again the following year about falling oil prices. In the San Jose Mercury News , Raymond F. DeVoe Jr. proposed that "Beware the Dead Cat Bounce" be printed on bumper stickers and followed up with a graphic explanation. [7] This quote was referenced throughout the 1990s and became widely used in the 2000s. [8]
"This applies to stocks or commodities that have gone into free-fall descent and then rallied briefly. If you threw a dead cat off a 50-story building, it might bounce when it hit the sidewalk. But don't confuse that bounce with renewed life. It is still a dead cat. The spot oil price has recovered from under $10 a barrel to over $13 -- but that also should not be confused with renewed life."
— Raymond F. DeVoe Jr., San Jose Mercury News, 28 April 1986 [9]
The phrase is also used in political circles for a candidate or policy that shows a small positive bounce in approval after a hard and fast decline. [10]
The standard usage of the term refers to a short rise in the price of a stock that has suffered a fall. In other instances, the term is used exclusively to refer to securities or stocks that are considered to be of low value. First, the securities have poor past performance. Second, the decline is "correct" in that the underlying business is weak (e.g. declining sales or shaky financials). Along with this, it is doubtful that the security will recover with better conditions (overall market or economy).
Some variations on the definition of the term include:
A "dead cat bounce" price pattern may be used as a part of the technical analysis method of stock trading. Technical analysis describes a dead cat bounce as a continuation pattern in which a reversal of the current decline occurs followed by a significant price recovery. The price fails to continue upward and instead falls again downwards, often surpassing the previous low. [13] This phenomenon can be difficult to identify at the time of occurrence, and like market peaks and troughs, it is usually only with hindsight that the pattern is able to be recognised. [14]
The phenomenon known as a dead cat bounce can be illustrated partly by the irrational and emotional behaviour of the market participants or traders. According to this theory, investors can sometimes not be rational or objective in their timing of the market; however, they are influenced by cognitive biases and emotions influencing and leading to herd behaviour, overreaction and underreaction. A dead cat bounce might prey on some of the following investor biases: [15]
Anchoring occurs from relying too much on a fixed reference point rather than adjusting expectations based on updated information. For example, a high or low occurred previously instead of looking at the macro-environmental factors. Some investors might take this information to mean that the stock/commodity is over or undervalued after a sharp decline and hope for a quick rebound in the form of a V-bottom.
Confirmation bias is the tendency to interpret information that confirms an individual’s pre-existing beliefs or hypotheses and ignore/dismiss significant contradictory evidence. This leads to investors selectively choosing what information they believe as long as it supports their optimistic outlook for the chosen stock. Thus, they downplay the crucial negative information as rumour or unimportant.
Overconfidence results from overestimating one's ability or knowledge of a particular stock or macro-environment and underestimating the associated uncertainty and risks. Overconfidence results in investors not diversifying, taking on too much risk or refusing to sell stocks at a stop-loss level.
These biases, either by themselves or in combination, can create a feedback loop in which the market is amplified in volatility and unpredictability as larger and larger amounts of investors react to the same signals and sentiments. The dead cat bounce is a prime example of a rebound fuelled by traders and speculators who bet on their optimistic views rather than the intrinsic or actual value of the stock. This results in a false sense of recovery as the stock begins to rally, and the subsequent drop in value reflects the actual supply and demand dynamics of the stock value.
To counteract these biases, implement a disciplined and evidence-based approach to investing, look at a longer time frame, or diversify in an index fund. These methods rely more on an objective set of criteria, such as the price-to-earnings ratio, the dividend yield, or the market capitalisation, to assess the relative attractiveness of a stock or market rather than trading based on emotion. Furthermore, they emphasise how important it is to diversify, be patient, and have a longer-term perspective which can reduce the impact and importance of short-term fluctuations and noise. By understanding the psychological traps that can lead to a dead cat bounce, investors can make achieving their financial goals more likely and avoid costly errors.
The causes behind a dead cat bounce are largely the result of these effects. It is often a combination of these effects which result in the dead cat bounce phenomenon.
Technical factors, such as a short position from many firms, can help in the formation of a dead cat bounce. As many investors buy back their shares to close a short position, the stock receives a temporary increase in demand, driving up the price of the stock. Additionally, if the stock has an established history of a stable, continuous and periodic fluctuation between a support price and a resistance price, a low stock price may result in investors buying shares under the belief that the stock price is still following the same trend. This has the same effect as the short covering where the price receives a short boost.
Positive news with relevancy to the stock can provide a temporary boost of investor sentiment. This can be the result of a partnership agreement or a new product. In turn, this provides a short boost to the demand for the stock even though the underlying cause of the decline in price has not changed.
The market sentiment refers to the attitude of investors towards a market. Should many stocks within the same financial market show a positive trend, then the entire financial market may be favored by investors. A "bullish" market refers to a market which is predicted to undergo a positive price movement. Should an entire market experience an increase in demand, even stocks with a falling price can be positively benefited.
Tactics used by market manipulators may be used to temporarily inflate prices in an effort of personal gain. Tactics such as a spreading false rumors or engaging in a pump-and-dump will result in a short-lived increase in price.
A market trend is a perceived tendency of the financial markets to move in a particular direction over time. Analysts classify these trends as secular for long time-frames, primary for medium time-frames, and secondary for short time-frames. Traders attempt to identify market trends using technical analysis, a framework which characterizes market trends as predictable price tendencies within the market when price reaches support and resistance levels, varying over time.
Investment is traditionally defined as the "commitment of resources to achieve later benefits". If an investment involves money, then it can be defined as a "commitment of money to receive more money later". From a broader viewpoint, an investment can be defined as "to tailor the pattern of expenditure and receipt of resources to optimise the desirable patterns of these flows". When expenditures and receipts are defined in terms of money, then the net monetary receipt in a time period is termed cash flow, while money received in a series of several time periods is termed cash flow stream.
The efficient-market hypothesis (EMH) is a hypothesis in financial economics that states that asset prices reflect all available information. A direct implication is that it is impossible to "beat the market" consistently on a risk-adjusted basis since market prices should only react to new information.
Day trading is a form of speculation in securities in which a trader buys and sells a financial instrument within the same trading day, so that all positions are closed before the market closes for the trading day to avoid unmanageable risks and negative price gaps between one day's close and the next day's price at the open. Traders who trade in this capacity are generally classified as speculators. Day trading contrasts with the long-term trades underlying buy-and-hold and value investing strategies. Day trading may require fast trade execution, sometimes as fast as milli-seconds in scalping, therefore direct-access day trading software is often needed.
The dividend yield or dividend–price ratio of a share is the dividend per share divided by the price per share. It is also a company's total annual dividend payments divided by its market capitalization, assuming the number of shares is constant. It is often expressed as a percentage.
Contrarian investing is an investment strategy that is characterized by purchasing and selling in contrast to the prevailing sentiment of the time.
Market timing is the strategy of making buying or selling decisions of financial assets by attempting to predict future market price movements. The prediction may be based on an outlook of market or economic conditions resulting from technical or fundamental analysis. This is an investment strategy based on the outlook for an aggregate market rather than for a particular financial asset.
Buy and hold, also called position trading, is an investment strategy whereby an investor buys financial assets or non-financial assets such as real estate, to hold them long term, with the goal of realizing price appreciation, despite volatility.
In finance, an investment strategy is a set of rules, behaviors or procedures, designed to guide an investor's selection of an investment portfolio. Individuals have different profit objectives, and their individual skills make different tactics and strategies appropriate. Some choices involve a tradeoff between risk and return. Most investors fall somewhere in between, accepting some risk for the expectation of higher returns. Investors frequently pick investments to hedge themselves against inflation. During periods of high inflation investments such as shares tend to perform less well in real terms.
A stock trader or equity trader or share trader, also called a stock investor, is a person or company involved in trading equity securities and attempting to profit from the purchase and sale of those securities. Stock traders may be an investor, agent, hedger, arbitrageur, speculator, or stockbroker. Such equity trading in large publicly traded companies may be through a stock exchange. Stock shares in smaller public companies may be bought and sold in over-the-counter (OTC) markets or in some instances in equity crowdfunding platforms.
In finance, an asset class is a group of financial instruments that have similar financial characteristics and behave similarly in the marketplace. We can often break these instruments into those having to do with real assets and those having to do with financial assets. Often, assets within the same asset class are subject to the same laws and regulations; however, this is not always true. For instance, futures on an asset are often considered part of the same asset class as the underlying instrument but are subject to different regulations than the underlying instrument.
Momentum investing is a system of buying stocks or other securities that have had high returns over the past three to twelve months, and selling those that have had poor returns over the same period.
A market correction is a rapid change in the nominal price of a commodity, after a barrier to free trade has been removed and the free market establishes a new equilibrium price. It may also refer to several such single-commodity corrections en masse, as a collective effect over several markets concurrently.
In economics and finance, market manipulation is a type of market abuse where there is a deliberate attempt to interfere with the free and fair operation of the market; the most blatant of cases involve creating false or misleading appearances with respect to the price of, or market for, a product, security or commodity.
The advance–decline line is a stock market technical indicator used by investors to measure the number of individual stocks participating in a market rise or fall. As price changes of large stocks can have a disproportionate effect on capitalization weighted stock market indices such as the S&P 500, the NYSE Composite Index, and the NASDAQ Composite index, it can be useful to know how broadly this movement extends into the larger universe of smaller stocks. Since market indexes represent a group of stocks, they do not present the whole picture of the trading day and the performance of the market during this day. Though the market indices give an idea about what has happened during the trading day, advance/decline numbers give an idea about the individual performance of particular stocks.
A rally is a period of sustained increases in the prices of stocks, bonds or indices. This type of price movement can happen during either a bull or a bear market, when it is known as either a bull market rally or a bear market rally, respectively. However, a rally will generally follow a period of flat or declining prices.
In modern finance, a flash crash is a very rapid, deep, and volatile fall in security prices occurring within a very short time period followed by a quick recovery. Flash crashes are frequently blamed by media on trades executed by black-box trading, combined with high-frequency trading, whose speed and interconnectedness can result in the loss and recovery of billions of dollars in a matter of minutes and seconds, but in reality occur because almost all participants have pulled their liquidity and temporarily paused their trading in the face of a sudden increase in risk.
A share price is the price of a single share of a number of saleable equity shares of a company. In layman's terms, the stock price is the highest amount someone is willing to pay for the stock, or the lowest amount that it can be bought for.
The August 2011 stock markets fall was the sharp drop in stock prices in August 2011 in stock exchanges across the United States, Middle East, Europe and Asia. This was due to fears of contagion of the European sovereign debt crisis to Spain and Italy, as well as concerns over France's current AAA rating, concerns over the slow economic growth of the United States and its credit rating being downgraded. Severe volatility of stock market indexes continued for the rest of the year.
In finance, a bull is a speculator in a stock market who buys a holding in a stock in the expectation that, in the very short-term, it will rise in value, whereupon they will sell the stock to make a quick profit on the transaction. Strictly speaking, the term applies to speculators who borrow money to fund such a purchase, and are thus under great pressure to complete the transaction before the loan is repayable or the seller of the stock demands payment on settlement day for delivery of the bargain. If the value of the stock falls contrary to their expectation, a bull suffers a loss, frequently very large if they are trading on margin. A bull has a great incentive to "talk-up" the value of their stock or to manipulate the market of their stock, for example by spreading false rumors, to procure a buyer or to cause a temporary price increase which will provide them with the selling opportunity and profit they require.
