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The dead-cat bounce
is the name of this event pattern. Price makes a dramatic drop, averaging 30%, before
bouncing only to resume the decline at a more leisurely rate. Which industries are more
likely to have stocks that dead-cat bounce? For the answer, click
here. For more information see pages
829 to 843 of the book Encyclopedia of Chart
Patterns, Second Edition and the following...
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Identification Guidelines
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Characteristic |
Discussion |
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Price gap |
Price usually gaps downward,
closing 15% to 70% lower than the prior day. The average event decline from prior close to trend low is 31%. |
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Trend low |
Forty-six percent make a lower low the next
day, 17% continue lower the next day, then 9%, and then 3%, respectively. From the event day to the trend low averages 7 days. |
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Bounce |
After the event day decline,
price bounces. Twenty-two percent will close the gap during the bounce phase, 38%
will close it in 3 months, and 58% will
close the gap in 6 months. The average bounce height from event low to bounce high
is 28% and takes 23 days. |
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Post bounce decline |
Once the bounce completes,
price resumes declining, averaging 30% from the bounce high to postbounce low in 49 days. This places price an average of
18% below the event low 67% of the time. |
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Second dead-cat bounce |
Twenty-six percent will have a second dead-cat
bounce measuring at least 15% within 3 months, and 38% will dead-cat bounce within 6 months. |
Trading Tips
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Trading Tactic |
Explanation |
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Bounce |
The larger the event day decline,
the larger the bounce and the longer it takes for the bounce to reach the bounce high. |
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Sell |
If you own the stock, wait for the
bounce to peak and then sell. |
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Swingers |
Swing traders can buy near the event
trend low and ride price upward until it peaks in the bounce phase. Only try this if the event day decline is a large one,
say over 30%. Event losses (from the close the day before the event to the trend low) above the median 28% decline had bounces
averaging 35% in 25 days. Those below the median bounced 22% and took 20 days. |
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Short |
For experienced traders, short the
stock at the top of the bounce and ride price lower. Expect price to drop to at least the event trend low. |
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Example
The above figure shows an example of a dead-cat bounce. On July 5, 2001, a broker issued a report that said
Amazon.com would beat the consensus estimate for earnings. It didn’t. When Amazon.com announced earnings results
on July 23, they were below expectations. After the stock opened, price closed 25% lower. Price made a lower low the
next day and then started a recovery. Price bounced upward for about a week and then turned down. When price finally
began a recovery, it had bottom 66% below the close the day before the earnings announcement.
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