When the price of a security or asset rises briefly after a long drop, it is called a dead-cat bounce.
In the 1980s, the term “dead-cat bounce” was used in colorful ways to talk about fake rallies. A false rally is usually a short-term rise in stock prices after a drop. When this happens, investors usually think that prices have reached the bottom and that a long-term recovery is likely, but a rally doesn’t happen. A rally like this can be compared to a dead cat. Even if a dead cat jumps up and down, it’s still dead.
A dead-cat bounce is also called a short-lived rally or a sucker’s rally.
WHAT IS THE DURATION OF A DEAD-CAT BOUNCE?
A dead-cat bounce is a short period of gains that can last for a day, a few days, or even a few weeks. Still, it’s hard to know, and investors usually get back into the market with the “buy on the dip” mentality.
HOW TO IDENTIFY A DEAD-CAT BOUNCE
It is difficult to identify a dead-cat bounce in real-time pricing, but it can be identified retrospectively. When a bear market follows a lengthy bull market, for instance, there are likely to be instances of transitory price increases that are not likely to be sustained.
Examining the market’s fundamentals is one approach to identify a dead-cat bounce. During the first half of 2022, the stock prices of several corporations plummeted by at least 20 percent from their peaks, indicating that their shares entered bear market territory.
Example of a dead-cat bounce: JPMorgan Chase (NYSE: JPM)
Examine the following price chart for JPMorgan Chase; its shares declined by 27 percent from the beginning of the year to May 20, 2022, compared to the 19 percent decline of the S&P 500 Index. The stock reached its all-time high in late 2021, following a protracted uptrend that began in April 2020. A month earlier, in March 2020, when the Covid epidemic sparked fears of a weakening U.S. economy, the share values of numerous corporations fell to multi-year lows.
Investors were concerned that rising interest rates would reduce the bank’s profits when the Federal Reserve tightened monetary policy in the first half of 2022 to control inflation. Higher borrowing prices may cause consumers to take out fewer loans, lowering interest income—the primary source of profit for many banks.
Even though there were times when the price of JPMorgan shares went up, the overall trend in the first half of 2022 was down. That means that investors who bought shares of the bank during the short times when they went up, at the end of January and in the middle of March, were left with paper losses.
In the chart below, you can compare the price of JPMorgan’s stock to that of March 2020, when the Covid pandemic began. Prices dropped sharply in March 2020, but they went back up in April and the following months as fears of a recession in the U.S. faded. That was a sudden change in price, but dead-cat bounces are the opposite. They cause people to put money into the market even though share prices are still going down.
USES IN TECHNICAL INDICATORS
A dead-cat bounce can be shown by certain technical indicators. In the charts above, the 14-day relative strength index for JPMorgan showed that the stock was oversold on some days between January and May. Even after the price fell below 30 on the RSI, which means it was time to buy, shares kept going down. That could mean that technical indicators like relative strength aren’t a good way to predict how a stock’s price will move in the future, and investors could be fooled into thinking that a reversal is likely.
