Understanding the Dead Cat Bounce Strategy in Trading
Think of crypto trading like playing chess. To do well, you need to make smart moves and use different strategies depending on the situation. One common strategy in trading is called the Dead Cat Bounce, even though the name might sound a bit grim.
Imagine throwing a lifeless cat out of a window — it might bounce a little, but only for a short time. Similarly, in trading, a Dead Cat Bounce happens when the price of an asset goes up briefly after a big drop. It tricks traders into thinking the asset is about to turn around, but it’s usually just a temporary improvement.
In this article, we’ll explain what the Dead Cat Bounce strategy is, how it applies to crypto trading, and how traders can use this knowledge to consistently make profits.
Understanding the Dead Cat Bounce
To understand the Dead Cat Bounce strategy, think of a tall building with a cat on top representing a declining market. The building symbolizes a financial asset’s downward trend. Imagine someone unethically throwing the cat off the building.
When the cat hits the ground, it bounces temporarily, mirroring a short-term upward movement in the market after a prolonged decline. It’s important to note that the bounce doesn’t mean the cat is alive, just as a market bounce doesn’t ensure a lasting upward trend. This is the essence of the Dead Cat Bounce strategy — differentiating between a genuine reversal and a mere temporary bounce.
How to Spot a Dead Cat Bounce
It is pretty easy to spot a dead cat bounce, since it usually happens because of the market herd mentality. This mentality involves where traders tend to follow the crowd and crypto assets sharply dumps within a short period. After it drops, the asset tends to jump in the following day as some buyers rush to buy the dips. At times, this jump is usually brief and ends up with further declines.
For example, assume that bitcoin that is in a sharp upward trend rises from $40000 to $45000. Then one day, it goes back to $40000 and then hurriedly rises to $430000. If it then drops to $35000, the initial jump can be said to be a dead cat bounce.
To identify this pattern, observe an asset previously in an upward trend that experiences a sudden sharp decline and then resumes its downward trajectory.
Dead Cat Bounce vs. Cat Climb
The trader who has mastered the Dead Cat Bounce strategy possesses a keen ability to differentiate between two scenarios: the Dead Cat Bounce and the Cat Climb.
1. Dead Cat Bounce: The Dead Cat Bounce is characterized by a temporary upward movement in the market that follows a significant decline. In this scenario, the bounce is typically less than 50% of the previous drop. This bounce can be interpreted as a signal that the market is likely to resume its downward trend, potentially with greater intensity.
2. Cat Climb: On the other hand, the Cat Climb represents a scenario where the bounce surpasses the 50% mark. This indicates that the market might be in for a more sustained recovery. The cat, metaphorically, is still alive and climbing back up the building. As opposed to dead cat bouncing, this might signal an upward move when it happens.
Interpreting the Bounce
To improve the accuracy of Dead Cat Bounce being used as a trading strategy, we can measure the distance from the beginning of the decline to the point of contact with the ground. The bounce’s height, relative to this distance
1. Less than 50% Bounce: If the bounce is less than 50%, it signals a high probability of a Dead Cat Bounce. Traders should be cautious, as the subsequent move is likely to be a meaningful decline.
2. Between 50% and 100% Bounce: A bounce that exceeds 50% but is less than 100% suggests the possibility of a Cat Climb.
3. Beyond 100% Bounce: If the bounce goes beyond 100%, approaching two-thirds or more, it strengthens the case for a Cat Climb. The subsequent pullback is expected to be shallower, indicating a potential reversal.
Practical Application and Trading Opportunities
Mastering the Dead Cat Bounce strategy provides traders with a valuable tool for making informed decisions on the market.
1. Exploiting Dead Cat Bounces: When recognizing a Dead Cat Bounce, traders can capitalize on the anticipated downward movement. Short-selling or using put options during this phase can lead to profitable trades. The deeper the subsequent decline, the more significant the potential gains.
2. Leveraging Cat Climbs: Identifying a Cat Climb opens opportunities for traders to enter the market with a bullish stance. Going long or using call options during the climb can result in profitable trades as the market experiences a meaningful upward move.
Closing thoughts
The Dead Cat Bounce strategy provides traders with a unique perspective on market reversals and bounces. For advanced traders, it can be a great strategy to make well-informed decisions and consistently position for profitable opportunities. However, for new traders, developing patience, discipline, and a focus on long-term charts is advisable.
Disclaimer: The opinions expressed in this blog are solely those of the writer and not of this platform.
