Dead Cat Bounce

Wall Street has a rather grim joke: "Even a dead cat will bounce if it falls from a great height." One of the earliest uses on record is a 1985 Financial Times article, and the phrase spread from there through Wall Street and the rest of the financial world. It compares the market to a falling object that springs back off the ground because of physical elasticity.

The same thing happens in stock markets. When a single stock or the whole market crashes steeply, investors who had bet against it buy shares back to lock in their profits (short covering). Other people think "it's gotten so cheap!" and rush in. Together, they push the price up for a short while.

But the rise isn't caused by better company earnings or a healthier economy. It's just a natural technical rebound after a crash, so before long the price returns to its original downward trend.

When prices fall day after day, people feel anxious and scared. Yet in the back of their minds, they cling to a thin hope: "Maybe it's finally hit bottom and will head back up." Then the price turns green for a day or two, and suddenly their resolve wavers.

Driven by the fear that "if I don't buy now, I'll miss out," they rush in and put money down. Traders call this getting caught in a bull trap, or trying to catch the bottom and getting trapped instead. When the bounce stops and the price sinks lower than before, those who jumped in take big losses.

In the middle of a down market, it's very hard to tell a real recovery from a fake one. That's why even professional investors try to follow a rule of never calling the bottom too early.

So how can you tell a true bottom and rebound from a dead cat bounce? The honest answer is that in the moment the rebound happens, nobody can tell for sure. You only know with time: does the price break above the previous high before the bounce, with lows getting higher and higher? Or does it fall back below the earlier low?

There are a few hints, though. A real trend reversal is often backed by fundamental changes in the environment, such as recovering company profits or interest rate cuts. That said, prices sometimes hit bottom before those changes show up in the numbers. A dead cat bounce, on the other hand, often happens when the underlying bad news hasn't changed at all. Prices simply bounce for a while on low trading volume just because they fell so far.

That's why the name "dead cat bounce" is usually applied only afterward, once the bounce is over and the price has broken below its low. People look back at the chart and give it that label.