Invest
What does 'dead cat bounce' mean?
A dead cat bounce is a stock market phenomenon that can result in the loss of investments. Learn how it increases risks for investors.
What does 'dead cat bounce' mean?
A dead cat bounce is a stock market phenomenon that can result in the loss of investments. Learn how it increases risks for investors.
A ‘dead cat bounce’ is a stock market phenomenon where continuous down trends are interrupted by small spikes. This gives investors the idea that a certain stock is in recovery or that the market is experiencing a correction.
But in most cases, the stock is really on the verge of collapsing. At its core, a dead cat bounce is only a temporary recovery—which means the underlying business will eventually close down
Some investors may be fooled into thinking that the short recovery will continue, so they buy more shares to benefit from the increase in value. However, this increases the possibility of loss of investment capital.
When do dead cats bounce?
A dead cat bounce typically happens during bear markets when companies struggle with a cycle of decline; however, the phenomenon is not limited to bearish markets.
A stock in continuous decline that suddenly experiences a market rally may already be a dead cat which simply bounced. However, not all rapid increases in stocks are caused by a dead cat bounce: the cycle of decline and spikes happens to any troubled business.
There’s no definite indicator that how to identify a dead cat bounce, because they are usually identified in hindsight—or after believing that an upswing is the beginning of a market correction.
How does a dead cat bounce happen?
The bounce happens when investors rally to buy a declining stock creating a false increase in demand which could be perceived as a market recovery. Two possible reasons for stocks to trigger a ‘buy’ signal are short selling and error in analysis.
Here’s how they contribute.
Short selling is when investors borrow shares of a declining stock from brokers to sell them at current market value. Once its value declines further, the investor buys back the same number of borrowed shares and returns it to the broker—but what does it have to do with dead cat bounces?
Buying declining shares creates a demand that increases the value of a particular company, leading to an ‘improved’ performance. Unless the company can sustain that upswing on its own, the increase in value is only temporary and would eventually return to its declining state.
Error in analysis may occur when a stock is predicted to have reached the bottom or when ‘buy’ signals are triggered by low price/earnings ratio and similar indicators. When investors purchase the declining shares, they can trigger a buying spree, which leads to a reversal in the company’s trajectory. However, the reversal quickly returns to its previous state of decline.
Dead cat bounce example
Let’s assume that a company’s share price declined by 60 per cent in a span of 12 weeks during a particularly difficult bearish market.
If there is a sudden upswing in its performance on the 13th week due to a buying spree, it is possible that some investors are simply trying to cash in on its decline by short selling the stock. If an inexperienced investor mistakes it as a profitable investment and purchases many units, they may end up losing their much of, if not the entire, capital once the stock plummets.
This information has been sourced from The Oxford Club.
About the author
About the author
Stock market
International stocks: Diversifying your portfolio beyond Australia
In an increasingly globalized market, Australian investors have the opportunity to enhance their investment portfolio by incorporating international stocks. Diversifying your investments globally can ...Read more
Stock market
Stock market rally likely to continue regardless of Fed minutes tone, says deVere CEO
The bull run that has propelled Wall Street's major indexes to record highs this month is expected to continue regardless of the tone of the upcoming Federal Reserve minutes, according to Nigel Green, ...Read more
Stock market
US stock rally driven more by valuation growth than earnings, leaving tech names vulnerable: Innova
The strong gains in US stocks over the past year, particularly in the technology sector, have been driven more by expanding valuations than underlying earnings growth, leaving them exposed to a ...Read more
Stock market
Sun Silver to make its ASX debut with a $13 million IPO
Sun Silver Limited (proposed ASX Code: "SS1") has announced the opening of its Initial Public Offering (IPO) today, aiming to raise a minimum of $10 million and a maximum of $13 million (before costs)Read more
Stock market
Nasdaq hits record high, underscores the value of tech in investment portfolios
The Nasdaq Composite's surge to an all-time high last Friday highlights the importance of incorporating technology into investment strategies. Read more
Stock market
Apple sets an unprecedented profit pace within the GAFAM group in 2023
After navigating through the economic difficulties presented in 2022, the technology sector has demonstrated resilience and growth, with many companies seeing increases in revenue and stock value. Read more
Stock market
Fintech startup okoora unlocks over $3 billion in forex savings for businesses
Fintech innovator okoora has announced it has saved customers a monumental amount over $3 billion through international foreign exchange transactions. Read more
Stock market
Google's Gemini edges out ChatGPT4 in groundbreaking AI showdown
Google's latest AI model, Gemini, has edged out OpenAI's ChatGPT4 in a recent set of rigorous multi-discipline tests, marking a significant milestone in the large language model (LLM) sector. Read more
Stock market
International stocks: Diversifying your portfolio beyond Australia
In an increasingly globalized market, Australian investors have the opportunity to enhance their investment portfolio by incorporating international stocks. Diversifying your investments globally can ...Read more
Stock market
Stock market rally likely to continue regardless of Fed minutes tone, says deVere CEO
The bull run that has propelled Wall Street's major indexes to record highs this month is expected to continue regardless of the tone of the upcoming Federal Reserve minutes, according to Nigel Green, ...Read more
Stock market
US stock rally driven more by valuation growth than earnings, leaving tech names vulnerable: Innova
The strong gains in US stocks over the past year, particularly in the technology sector, have been driven more by expanding valuations than underlying earnings growth, leaving them exposed to a ...Read more
Stock market
Sun Silver to make its ASX debut with a $13 million IPO
Sun Silver Limited (proposed ASX Code: "SS1") has announced the opening of its Initial Public Offering (IPO) today, aiming to raise a minimum of $10 million and a maximum of $13 million (before costs)Read more
Stock market
Nasdaq hits record high, underscores the value of tech in investment portfolios
The Nasdaq Composite's surge to an all-time high last Friday highlights the importance of incorporating technology into investment strategies. Read more
Stock market
Apple sets an unprecedented profit pace within the GAFAM group in 2023
After navigating through the economic difficulties presented in 2022, the technology sector has demonstrated resilience and growth, with many companies seeing increases in revenue and stock value. Read more
Stock market
Fintech startup okoora unlocks over $3 billion in forex savings for businesses
Fintech innovator okoora has announced it has saved customers a monumental amount over $3 billion through international foreign exchange transactions. Read more
Stock market
Google's Gemini edges out ChatGPT4 in groundbreaking AI showdown
Google's latest AI model, Gemini, has edged out OpenAI's ChatGPT4 in a recent set of rigorous multi-discipline tests, marking a significant milestone in the large language model (LLM) sector. Read more