What Is a Dead Cat Bounce?

The term dead cat bounce is associated with the stock or the securities market.

A dead cat bounce refers to a situation where stock prices rally temporarily, in a bear market, before continuing the fall again.

When the financial markets experience a prolonged fall in asset prices, we call it a bear market.

A rally refers to a rapid increase in asset prices.

What causes a dead cat bounce?

Typically, a bearish phase in the financial markets is brought about by economic uncertainty. The price of a particular stock may fall when people are uncertain about the economic prospects of the company or the economy as a whole.

In case of an economic downturn, the stock prices fall as people start selling off shares fearing a contraction in the future earnings of the companies on account of reduced economic activity.

The markets thus, enter a bearish phase characterized by a sustained fall in asset prices.

The dead cat bounce happens when after a prolonged fall in a bearish market, asset prices recover slightly. This happens when people start buying shares hoping that the markets may have bottomed-out i.e reached their lowest point.

Once this recovery is noticed, others move in to buy shares in the anticipation that there would be no further fall from the current price levels.

Money flows into the markets again and the prices rise rapidly.

These buying decisions are based more on the ‘fear of losing’ out than on economic realities.

When the reality sets in and people understand that an economic revival is not really in sight, the markets continue the free-fall, and we experience the dead cat bounce phenomenon.

The origin of the “dead cat bounce” name!

The name dead cat bounce originates from the fact that if you drop a dead cat hard enough, it will bounce. The dead cat representing the state of the company/economy and the “bounce” – the temporary rise in prices.

How to identify a dead cat bounce?

Sadly, the markets often behave irrationally and there is no way to tell a dead cat bounce before one has happened.

However if, in a bearish market you encounter a rapid spike in price; while the economic indicators tell you otherwise, there could be a dead-cat bounce brewing.

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