The Dead Cat Bounce: A Bear In Bull's Clothing?

Is the recession really over, or is it a dead cat bounce?

There's an old saying in investing: even a dead cat will bounce if it is dropped from high enough. The dead cat bounce refers to a short-term recovery in a declining trend.




What Causes A Cat To Bounce?
There comes a time in every bear market when even the most ardent bears rethink their positions. When a market finishes down for six weeks in a row, it may be a time when bears are clearing out their short positions to lock in some profits. Meanwhile, value investors may start to believe the bottom has been reached, so they nibble on the long side. The final player to enter the picture is the momentum investor, who looks at his or her indicators and finds oversold readings. All these factors contribute to an awakening of buying pressure, if only for a brief time, which sends the market up.

Dead Cat or Market Reversal?
As we noted earlier, after a long sustained decline, the market can either undergo a bounce, which is short-lived, or enter a new phase in its cycle, in which case the general direction of the market undergoes a sustained reversal as a result of changes in market perceptions.

How can investors determine whether a current upward movement is a dead cat bounce or a market reversal? If we could answer this correctly all the time, we'd be able to make a lot of money. The fact is that there is no simple answer to spotting a market bottom. (Picking market bottoms takes some technical know-how. Check out Market Reversals And How To Spot Them to learn more.)

It is crucial to understand that a dead cat bounce can affect investors in very different ways, depending on their investment style.

Style and Bouncing
A dead cat bounce is not necessarily a bad thing; it really depends on your perspective. For example, you won't hear any complaints from day traders, who look at the market from minute to minute and love volatility. Given their investment style, a dead cat bounce can be a great money-making opportunity for these traders. But this style of trading takes a great deal of dedication, skill in reacting to short-term movements and risk tolerance.