A temporary recovery in prices during a prolonged bear market.
A Dead Cat Bounce refers to a temporary recovery in prices during a prolonged bear market. It is a small, short-lived recovery in the price of a declining asset, such as a stock or cryptocurrency, followed by a continuation of the downward trend. The term is derived from the notion that "even a dead cat will bounce if it falls from a great height." These false recoveries often trap inexperienced investors who mistake the temporary upswing for a market reversal.
For instance, if a cryptocurrency drops from $100 to $50 (a 50% drop), it might then recover to $75 (a 50% recovery), only to continue its downward trend afterwards, perhaps falling to $30. This temporary recovery is known as a dead cat bounce. Many traders who bought at $75 thinking the market had reversed would face significant losses as the downtrend continued.
The term "Dead Cat Bounce" originated from the financial markets and is often used by traders to describe a pattern in price charts. It is based on the morbid joke that even a dead cat will bounce if it falls far enough and fast enough. The term became widely used on Wall Street in the 1980s but has become especially relevant in the highly volatile cryptocurrency markets of today.
The term was popularized by Wall Street traders in the 1980s. It's used to caution investors not to be fooled by a brief rally during a bear market. In cryptocurrency trading, where volatility is significantly higher than traditional markets, dead cat bounces can be more pronounced and frequent, making them particularly dangerous for new traders.
Identifying a dead cat bounce can be challenging as it requires predicting the future direction of price movements. Traders often use technical analysis tools, such as trend lines, moving averages, volume indicators, and momentum oscillators to help identify potential dead cat bounces. Key signals include low trading volume during the recovery, failure to break significant resistance levels, and bearish divergence in technical indicators.
For example, a trader might look for a sudden increase in trading volume during the price recovery as a potential sign of a dead cat bounce. This is because a genuine market recovery is usually accompanied by high and sustained trading volume, while a dead cat bounce might not see as much trading activity. Additionally, if the price fails to break through previous support levels (now acting as resistance) and technical indicators like the Relative Strength Index (RSI) show weakening momentum during the bounce, these could be signs that the recovery is temporary.
Sometimes, an asset can experience multiple dead cat bounces before the downward trend is reversed. Each bounce can give false signals that the downward trend is over, leading to potential losses for traders who buy in during these temporary recoveries. These patterns often occur in waves, with each bounce typically reaching a lower high than the previous one, creating a stair-step pattern downward.
During the 2018 cryptocurrency bear market, Bitcoin experienced multiple dead cat bounces as its price declined from nearly $20,000 to under $4,000. Each time the price would recover by 20-30%, some traders would declare the bear market over, only to see prices continue to fall to new lows in the following weeks. Similar patterns occurred in altcoins like Bitcoin Cash, which saw several rallies during its extended downtrend.
Dead cat bounces are often driven by psychological factors in the market. After a sharp decline, some investors see the lower prices as a buying opportunity, while others who missed selling earlier use the temporary recovery to exit their positions. This creates a brief period of buying followed by renewed selling pressure once these short-term factors dissipate.
In cryptocurrency markets, dead cat bounces can be particularly pronounced due to the strong emotional reactions of retail investors. For instance, after Bitcoin Cash experienced a significant drop during a market correction, a brief 15% recovery might occur as bargain hunters step in, only to be followed by continued selling as more investors use the higher prices as an opportunity to exit their positions with somewhat reduced losses.
Experienced traders employ specific risk management strategies to protect themselves from the pitfalls of dead cat bounces. These include using stop-loss orders, scaling into positions gradually rather than all at once, and waiting for confirmation of a trend reversal through multiple technical indicators and higher timeframe analysis.
A trader interested in buying Bitcoin Cash after a significant price drop might wait for confirmation of a genuine reversal by looking for sustained trading volume, breaks of key resistance levels, and a series of higher lows and higher highs before establishing a position. Additionally, they might use a stop-loss order placed below a key support level to limit potential losses if the apparent recovery turns out to be just another dead cat bounce.
All terms and definitions may update as the Cryptionary improves.