What Is a "Dead Cat Bounce?"

If you follow the stock market, then you have probably heard the term "Dead Cat Bounce" at one time or another. If you hear this time and wonder what exactly it means, then this article is for you.

The term is derived from the saying "Even a dead cat will bounce when dropped from a great height." Now how does this apply to the stock market?

Let's take a stock called XYZ. XYZ is trading at $40 and then announces really bad earnings news after the bell. The stock opens at $22 the next day, and then plummets an additional $15 over the next week. A week after its bad earnings news, the stock is now trading at $7.

Everything is doom and gloom, but suddenly the stock rises $3 over the course of a couple of days without any good news accompanying the rise. This would best be described as a "dead cat bounce."

When a stock is trading lower over the course of days or weeks, there will normally be days when the stock is suddenly strong and trades higher, even though the gloomy situation surrounding the company hasn't arrived.

This is normally caused by either:

1. Value investors determining that the price is right to buy or start accumulating shares

2. Short-sellers covering their positions.

Nothing has fundamentally changed with the company; it is simply a matter of value investors starting to accumulate positions or short-sellers beginning to cover. The stock may in fact be dead with no hope of ever recovering, but it will still bounce now and again, giving false hope to its investors. This is known as a "dead cat bounce."

Filed under: Stock Market Education | General Knowledge