When a dead cat drops from the rooftop of a building, it hits the ground, then it bounces and falls back down to the floor dead. This is analogous to the price action of an asset when its price drops from a local top to a local bottom then recover before continuing to fall again.
The phrase was coined in December 1985 when Singaporean and Malaysian stock markets rebounded after a heavy drop during the recession. Journalists Horace Brag and Wong Sulong from the Financial Times noted that the market recovery was “what we call a Dead Cat Bounce”. The phrase has been also used in politics to describe a policy that shows a slight positive rebound in popularity after a rapid decline.
A dead cat bounce, also known as a sucker’s rally, is a price action where the price of an asset falls from a local top, hits a local bottom, then bounces back up briefly before continuing its downward momentum. From a technical point of view, the price should dip a significant percentage at the open, then eventually make a temporary recovery, ideally to the 0.618 Fibonacci retracement level for crypto, creating a lower high, and should next start to fall back down until putting a lower low.
The image above is an example of a dead cat bounce on the bitcoin 4 hourly chart happening live at the time of writing this article (March 10, 2022). The price fell 18% from its local top at 45K to a local bottom at 37K, then retraced back to the 0.618 fibs, and now it is back down to 39K. Closing a daily candle below 39K would confirm the continuation of the pattern until creating a lower low at 36K or lower.
How to trade a dead cat bounce
Let’s be clear that a dead cat bounce is not easy to predict. Traders may rely on volume and other indicators to confirm a dead cat bounce and may have to wait for the price to close below a certain level before initiating a trade and pay attention to the macro environment and overall market conditions, especially on longer time frames.
Traders can employ a long or short position to profit from a dead cat bounce trade. They can either open a long position after the initial fall hits a floor or a short position after the recovery or retracement.