What does a Dead Cat Bounce pattern tells traders about a stock?
A:
A dead cat bounce is a technical trading pattern that signals to traders the continuation of a downtrend, that a stock’s price is likely to continue to decline. The chart pattern appears when only a small, short-lived recovery follows a significant, severe decline in a stock’s price. This trading pattern is considered a relatively definitive indicator of market weakness. It derives its name from the notion expressed in the adage, “Even a dead cat will bounce if you drop it from high enough up.”
The key element that denotes a dead cat bounce in stock trading is the fact that the stock price only recovers very slightly after having fallen very severely. For example, a classic dead cat bounce occurs when a stock falls from $70 to $30 a share, and then only manages to rise back up to $34 to $35 a share before turning back to the downside. This relative lack of bounce, that contrasts with typical 30-50% upward retracements that often occur after a large move down, indicates that, even at the much lower price level, there is still very little interest in the stock on the part of buyers. No large number of traders is looking to scoop up the stock at what might be considered a bargain price. Rather, the very slight price rise is more indicative of sellers merely taking profits on at least a portion of their short selling positions.
Another indicator of market weakness is the fact that any rally in price is short-lived. The market soon turns south again, resuming a downward trend. Such price action indicates there is renewed interest in selling the stock, even at a price that is just slightly higher than the most recent low. Once price falls below the lowest level reached immediately prior to the slight counter-trend rally, the dead cat bounce technical trading pattern is considered confirmed, and traders look for the stock price to gradually fall lower.
TAGS:Technical AnalysisTechnical IndicatorsChart Types
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Original article:
What does a Dead Cat Bounce pattern tells traders about a stock?
