What is a dead cat bounce in crypto trading?
Even a dead cat will bounce if dropped at a certain height
A dead cat bounce refers to a price chart pattern used in the world of finance; it presents the financial activity of a certain asset that goes through a brief price recovery following a long downward trend. The bounceback of the asset in question is again followed by a return to the downward trend.
In other words, a dead cat bounce means that an asset is experiencing a temporary and deceptive recovery of its price- the asset’s price goes through a brief upward movement and gives the impression that the market might be reversing.
This term stems from the saying ‘even a dead cat will bounce if dropped at a certain height’, which is frequently used in both traditional and crypto markets to monitor an asset’s behaviour. Predicting a dead cat bounce can be complicated, but there are technical and fundamental analysis tools to help in the process.
The name of this financial term seems a bit strange, but it illustrates the idea that even a dead cat will bounce after falling from a big height, indicating the cat still isn’t alive. In financial terms, the dead cat bounce highlights the fact that a temporary rise in price refers only to a reflexive rebound and doesn’t mean that a bull run is going to happen.
The world of finance, either traditional or crypto, is filled with terms many users are not accustomed to. If you want to know what bear markets, bull runs, or a bullish trend reversal are, we suggest reading this article: 'What do the terms Bull & Bear Market mean?'.
What does it mean when a dead cat bounces?
Dead cat bounces don't reflect the true value of a particular asset or the movement of the asset's price. Instead, they show the way the market's collective psychology is following.
Financial markets have been known for volatile price movements that frequently stem from various factors. Knowing what a dead cat bounce is has become essential to understanding the patterns of financial market movements and its unpredictable nature.
This price pattern used by technical analysts refers to a continuation pattern where the first bounce appears to be a reversal of the prevailing trend, yet a continuation of downward price movements rapidly follows it.
It is not unusual for downtrends to be interrupted by short periods of recovery or brief rallies where prices go up. Short periods of recovery don’t indicate that a dead cat is bouncing, yet it could be a result of investors or traders closing out short positions or buying assets.
The price pattern known as a dead cat bounce is typically spotted in hindsight, and analysts tend to spot certain technical indicators to predict that the price recovery will be only temporary.
Dead cat bounce patterns sometimes suggest that certain underlying assets might be bad investments, but not all correction moves in the bear market are considered dead cat bounces.
Is a dead cat bounce bad?
In contrast to the popular belief, a dead cat bounce is not always a bad thing. When it comes to seasoned day traders and skilled investors, it can be seen as an opportunity to gain profits.
In other words, if traded wisely, a dead bounce can be a good tool for both long-term investors and short-term traders.
Keep in mind that nothing in this article is intended as or shall be understood as financial advice. When dealing with financial markets, either traditional or crypto, it is important to demonstrate a high level of financial responsibility and do your research as well as consult a professional.
A cat always lands on its feet, but the dead one can only bounce. Because of this, it is important to gain enough knowledge and not confuse a dead cat bounce with an asset’s price that is truly reversing. The dead cat bounce can be tricky, especially in the crypto space where volatility is higher.
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A little bit of history
The dead cat bounce pattern has existed as long as financial asset markets have. However, this term was first used back in 1985 in the context of stock markets located in Singapore and Malaysia. Both countries were going through a recession when several assets seemed to be recovering rapidly only to go back to their prevailing downtrend.
It has also been noted that the term may originate from the turbulent state of the financial markets in the United Kingdom in the early 1980s, characterised by short-term recoveries in a declining trend.
The term originated from Wall Street saying that even a dead cat will bounce if it falls from a great height. It was coined by Financial Times journalists Horace Brag and Wong Sulung.
With increasing volatility in many asset markets through the 1990s, the dead cat bounce term became more popular. It became not only a part of the financial language, but it can be used in the political sense as well, referring to a candidate whose approval ratings recovered shortly, only to go down again.
A historical example of a dead cat bounce
One of the most popular examples of a dead cat bounce is linked to the 2008 financial crisis. Following a prolonged decline in the global financial markets, many stock prices experienced a significant downtrend. However, there were periods associated with a temporary price increase which led some traders to believe that the worst was over.
For example, the banking sector experienced a few dead cat bounces back then which were short-lived, indicating the need to distinguish between a dead cat bounce and a genuine reversal.
Another example is linked to the Dot-Com bubble in the late 1990s when the stock market experienced hype driven by investments in tech companies. When the bubble burst, many stock prices faced a significant decline. The prolonged decline was interrupted by dead cat bounces that lured investors and bullish traders into thinking that the bad times were over.
Bitcoin dead cat bounces
A Bitcoin dead cat bounce presents a temporary recovery in the price of Bitcoin after a significant decline, suggesting a short lived upward movement rather than a stable reversal.
In the past, Bitcoin has experienced a few dead cat bounces such as the 2018 all-time-high drop, the 2020 market turmoil, and the 2021 price fluctuations.
Therefore, it is more than just a catchy term- this concept embodies the uncertainty and need for knowledge within financial markets and especially the cryptocurrency market.
Ethereum's potential dead cat bounce
Back in June 2022, Ethereum’s price came down to $880 following a broad volume on cryptocurrency exchanges. Many cryptocurrencies have reached new prolonged declines due to the persistent bear phase in traditional markets which had a ripple effect on the crypto market.
In the ongoing bear market, Ethereum experienced a sudden uptrend which many investors and traders saw as a dead cat bounce instead of a market reversal.
How to spot a dead cat bounce?
There are three main stages of a dead cat bounce. The first stage is associated with a sharp price drop as the asset’s actual value experiences a big fall. The drop in question goes through levels where the price stops failing, referred to as support levels. Imagine a ball rolling off a table and the quick drop that happens.
Secondly, look for a small and rapid rise in price. Following a big fall, the price can go up a little and experience a short-lived recovery. The rise usually isn’t very high. What happens after the rise determines whether it is a dead cat bounce; a true dead bounce makes the price go down again, sometimes even lower than before. Now imagine a ball hitting the floor and bouncing just a bit but continuing to roll downwards.
When trying to recognise whether it is a dead cat bounce or a market reversal going on, it is important to look at the bigger picture such as the overall market sentiment. Additionally, it is essential to assess all the fundamental factors driving the initial decline.
Are there any limitations in identifying a dead cat bounce?
It is not an easy task to identify a dead cat bounce. Most of the time, it can only be identified after it happens. Traders might notice a small rally after a long decline and this is a dead cat bounce when it could be a trend reversal instead.
Dead cat bounces in crypto trading
Just as traditional financial markets can go through dead cat bounces, so can the crypto market. Many concepts and theories that stem from traditional finance can be applied within the crypto sector.
When it comes to a dead cat bounce, the same principle applies- a certain crypto asset or the crypto market as a whole can experience a prolonged downturn interrupted by a brief recovery uptrend.
Within the crypto ecosystem, this can happen when the market is entering the bear phase or being influenced by particular other factors; for example, investors can sometimes purchase a stash or crypto or stock up on tokens while the prices are low which causes a rapid spike.
How to spot a dead cat bounce in the crypto market?
Like spotting dead cat bounce patterns in traditional markets, there are several telltale signs that a crypto asset might be going through a dead cat bounce.
For example, check out the trading volume. Sudden spikes are sometimes caused by brief periods of increased trading that are still not enough to reverse the ongoing market conditions. Therefore, if a crypto asset with a declining value seems to go up, look at the transaction volume- if the trading volume is low, a dead cat bounce might be happening.
As mentioned above in the text, price spikes produced by a dead cat bounce are usually lower than all-time highs. Additionally, be aware of previous and current market movements of an asset. While nobody knows for certain whether a dead cat bounce occurred until it happens, being aware of all conditions on the market can help you in distinguishing false signals from true reversals.