What is a Dead Cat Bounce?
A dead cat bounce refers to a temporary recovery in a stock price or a temporary market rally after a significant downward trend.
How Does a Dead Cat Bounce Work?
For example, let's assume the market has been falling over the last ten weeks but there is a broad market rally in week 11. The rally is considered a dead cat bounce if it's short-lived and the market continues to fall again in week 12.
Most of the time, waffling causes a dead cat bounce. During a long downward slide, some investors may think that the market or a particular security has bottomed out. They begin buying instead of selling, or some may be closing out their short positions and pocketing gains. These factors create a little buying momentum, albeit brief.
Why Does a Dead Cat Bounce Matter?
A dead cat bounce is by definition a temporary change, but it can be very difficult (if not impossible) to reliably determine at the time if the rally is actually the beginning of a sustained reversal.
Short-term investors often enjoy a dead cat bounce because there is opportunity in the short-term change in direction.