In the capital markets, stock prices are not always trending or moving in one direction. Reversals do occur whenever price moves in one direction over an extended period. Trend reversals can occur whenever buyers overwhelm sellers after a prolonged sell-off, causing the price to reverse sharply and move upwards.
Likewise, a trend reversal can occur in an uptrend whereby sellers overwhelm buyers, conversely pushing prices lower. A trend reversal can occur because of:
- A piece of sudden news or development that causes a drastic change in trader’s sentiments
- A build-up in volume in the opposite direction
- Traders sensing overbought and oversold conditions
Whenever a reversal occurs, two situations can occur.
- Price can move in the opposite direction for a long.
- A reversal can fail, and price resumes its long term trend.
A dead cat bounce is usually one of the outcomes of a failed reversal.
What is a Dead Cat Bounce?
A dead cat bounce is a pattern that occurs whenever the price is trending lower. Once buyers flock to the market, on price moving lower significantly, the same triggers a reversal with price bouncing off the lows and start to move up.
Whenever a retracement to about 50% of the long-term downtrend occurs and prices reverses again and moves in the original trend’s direction, the same is implied as a dead cat bounce. The extra supply in the sell-off price causes the price to move past the initial low, conversely forming a new lower low.
An excellent dead cat bounce stock is one.
- That has a steep and lasting sell-off that concludes with a hammer or Doji Candlestick.
- That has a high short interest above 25%
A dead cat bounce is simply a continuation pattern whereby price bounces off a critical support level only for the bounce back to fail, resulting in the long-term downtrend.
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