A dead cat bounce is traditionally described (for example Investopedia) as “a small, brief recovery in the price of a declining market”. We day traders like to look at it a bit differently – because when we anticipate these bounces, we can take profits smartly and quickly.
For us, a dead cat bounce is the pull back we see after a very strong reaction to a news item, or any quick, strong movement, either up or down. The typical behavior to a significant news announcement is very strong movement, very quickly. But, once that strong movement peters out, sometimes after only a minute or two, we get that bounce, where the market retraces towards it’s price point just before the news came out.
Here are two charts showing the same event: the FOMC announcement on March 19th, 2014. The first chart, as you can see in the upper left corner, is the YM (Dow index futures contract), showing 15 second bars.
The price action you see here is quite typical of FOMC day action. The market sits around, hardly moving, “holding its breath”, so to speak, waiting to see what the fed is going to do. Then, when the announcement comes out, the market reacts with big moves.
The price plummets nearly 60 points in 1 1/2 minute – not unusual for an FOMC reaction! Then, we have a bounce up, coming most of the way back to the pre-annoucement price. That bounce up is the Dead Cat Bounce.
The second chart is the same day, the same announcement, but it is showing 500 tick bars. The formation is a bit different looking, but the bounce is just as clear.
Anticipate the Dead Cat Bounce
The point is that you should expect the bounce, know that it is highly likely to happen, when the market moves so fast in so short a time. Generally when you see a fast sharp move, you can expect an almost-as-fast, almost-as-sharp move back the other way, once the initial move is exhausted.
The Cat Bounces Both Ways
Here is one last chart to show you a Dead Cat Bounce occurring when the market moves up sharply (well, I guess that cat is now falling from the ceiling where someone tossed it ).
This is the ES (S&P index futures contract) showing 1 minute bars, with a positive reaction to the report of the ISM Non-manufacturing Composite Index.
The ES marched up 10 points in 3 minutes, then bounced right back down.
If you went long with the news, be sure to be ready to jump out quickly with a nice profit, just as that cat starts its bounce.
As always, please let me know your own experiences with Dead Cat Bounces, in the Comments below.