What Is a Dead Cat Bounce?
In financial markets, a dead cat bounce is a short-lived recovery in an asset price before it continues a major decline. The term is based on the saying that “even a dead cat will bounce if it falls from a great height.”
The bounce is temporary and does not mean the cat will recover.
The first reference to a dead cat bounce in the media occurred in December 1985, when the Financial Times quoted a broker as saying, “This is what we call a dead cat bounce.” This was a reference to a brief uptick in the financial markets in Singapore and Malaysia, which subsequently declined further and took several years to fully recover.
A Dead Cat Bounce in Crypto Markets
In the volatile cryptocurrency markets, prices fluctuate dramatically in short periods.
A dead cat bounce happens when a coin or token that has been in an extended downward trend suddenly turns higher. The change in direction can falsely suggest that the price will reverse and recover, but this is subsequently followed by a further drop in the price.
Why and How Does It Happen?
During the initial stages of a dead cat bounce pattern, it might appear to be a valid trend reversal. However, the price subsequently falls, breaking through previous support levels to new lows. This can also result in a bull trap, in which traders and investors open long positions expecting the market to continue moving higher and are then caught out by the resumption of the decline.
A dead cat bounce can be driven by various factors, including:
- Technical patterns or levels
- Market sentiment
- External events and news
When a cryptocurrency price falls sharply, some market participants might consider it to be oversold and at a profitable entry point. Media coverage or news about the cryptocurrency can also drive buying interest, lifting the price.
However, if the drivers behind the decline are still in effect, the price rise is typically unsustainable.
How to Identify a Dead Cat Bounce
For cryptocurrency traders and investors, recognizing a dead cat bounce is important to help prevent losses on a misplaced bullish position when the market is set to reverse course again.
- Look for confirmation. Before viewing an uptick in price as a trend reversal, wait for confirmation from a sustained rise in the price and an increase in trading volume.
- Refer to technical analysis. Use technical indicators and patterns such as moving averages (MAs), relative strength index (RSI), and moving average convergence divergence (MACD) to gauge the strength and sustainability of a potential price rebound.
- Conduct fundamental analysis. Determine whether the bearish market drivers have been resolved or are likely to continue weighing on the market. Positive news or sentiment changes can be short-lived and insufficient to sustain a true trend reversal.
The Bottom Line
A dead cat bounce can be a common occurrence in the highly volatile cryptocurrency markets. Understanding technical and fundamental indicators can help traders and investors identify it and avoid making losses on a coin or token that appears to be moving higher but will reverse course and resume an ongoing downward trend.
