What is a Dead Cat Bounce?
The term comes from the saying 'even a dead cat will bounce if dropped from high enough.' It describes a brief recovery during a sustained decline that tricks investors into thinking the bottom has been reached. During the 2008 crisis, the S&P 500 bounced several times before ultimately falling over 50% from its peak. Each bounce attracted buyers who then suffered further losses.
Why Temporary Bounces Occur
Short covering (short sellers buying back shares to lock in profits), bargain hunting, technical support levels, and hopes for policy intervention all trigger temporary rebounds. These forces are transient. If the fundamental cause of the decline, whether recession, credit crisis, or earnings deterioration, remains unresolved, selling pressure eventually overwhelms the bounce.
Distinguishing Real Recoveries
No method perfectly separates dead cat bounces from genuine bottoms, but clues exist. Recoveries accompanied by high trading volume are more likely to be real. Bounces on thin volume are suspect. A rally that fails to exceed the previous high before rolling over is a bearish signal. The safest approach after a sharp decline is patience: wait for a confirmed trend change rather than rushing to buy the dip.