When a dead cat bounce occurs in the market: peculiarities of the strategy
Brokerage activity has many nuances that must be taken into account when closing or opening trades. Specialists distinguish a number of important patterns, one of which is the cat bounce. It would be best to explain it with an example.
In a stock at the opening there is a drop of 5% or more from yesterday’s closing mark, with the price continuing to decline. After a while, the price drops 8%, after which a rally ensues. Some investors, who previously planned to buy shares, decide to open positions in order to buy securities at a discount of 5-8%. At the same time, the activity traders, who went into shorts in the morning, are covering their positions, which acts as fuel for the rebound. The price approaches the opening level, but the decline is still within 5%. Soon the price collapses again, as those traders who did not exit their positions exit the moment the price is near the opening value. This particular situation demonstrates a dead cat bounce.
The reason for this pattern is a gap down of about 5%. In general, the jump requires that the opening price is significantly different from the previous day’s closing value. If there is a stable volatility of the stock, then the gap value should be greater than 5%, otherwise this figure is enough.
Another important thing about the pattern is that the value should continue to fall for at least 5 minutes after the opening, ideally this period should be longer. If the price stops after the gap, then there will be no bounce.Such drops in the value of shares are observed as a result of the release of important news between trading sessions. Among them may be the publication of company reports, new laws.
Traders who use a dead cat bounce clearly watch the price movements and when it shows a bounce, go into a short. The reason for the short here is that the bounce won’t necessarily be long in time. The fact is that the stock has declined and investors are concerned, and a bounce serves as a great option for them to get rid of the securities. To that end, they drop the price even further. And it is in the trader’s interest to follow this process in order to have time to win and make a profit. An important point is the return of the value to the opening level, as it is likely to be a resistance point. At this time, it is necessary to open a short position, but it is better to take this step when the price resumes falling.
To track the onset of a dead cat bounce, you can use various stock screeners with current quotes. It is necessary to analyze those securities that have shown a big drop. It should be taken into account that the traded volume in the stock needs from 500 thousand, then they are suitable for transactions during the day.