Dead Cat Bounce Pattern

It is a phenomenon that occurs during a long downtrend, where a sharp V-shaped reversal is seen on the chart. The pattern is so named because, similar to a dead cat bouncing when it falls, even a down trending market will experience a temporary rebound before continuing its downward trend.

The Dead Cat Bounce Pattern is a term used in technical analysis of financial markets, specifically in Forex trading. It is not clear who first coined the term, but it is believed to have originated from traders in the London Stock Exchange in the early 1990s.

What is the Dead Cat Bounce Pattern?

The dead cat bounce pattern is a technical analysis strategy that is used to identify potential trend correction in the Forex market. It is based on the idea that even a dead cat will bounce when it falls from a height, and similarly, even a down trending market will experience a temporary rebound before continuing its downward trend.

Additionally, the dead cat bounce pattern is not just a price pattern, but it can also help to explain the participants’ repositioning in the market. Traders may move to the long side of the market, hoping that the market has already oversold and is now ready to bounce back.

How to spot the Dead Cat Bounce Pattern?

The dead cat bounce pattern is characterized by a sharp downward movement followed by a brief upward movement. The upward movement is typically short-lived and does not reach the previous high. The pattern is often used as a signal to sell or short the stock. It is triggered by short covering, as traders close their short positions to lock in profits when they believe the market has reached the bottom.

Dead Cat Bounce Pattern
Dead Cat Bounce Pattern

What are the reasons for a dead cat bounce to occur?

The term “dead cat bounce” refers to a short-lived recovery in the price of a currency pair that has recently experienced a sharp decline.

  • Short sellers increasing trades in a short period during a bearish market.
  • Short sellers looking for opportunities to profit during a downtrend.
  • Dip buyers searching for stocks to purchase at a discounted price.

These three factors create a buying pressure that drives up forex pair prices. However, this pressure is not long-lasting, as new short sellers enter the market after a short period of activity. When there are no more buyers, the prices drop again, repeating this pattern periodically.

What is the strategy for trading when this pattern is observed?

Trading during a dead cat bounce can be challenging, as market conditions may change over the course of a prolonged downtrend. It can be difficult to determine whether a rebound is a temporary dead cat bounce or a potential trend reversal. One tool that can be used to help identify the dead cat bounce pattern is the Fibonacci retracement indicator, which can be used to measure the depth of a rebound. Theoretically, a shallow retracement of losses during a long downtrend can indicate a dead cat bounce pattern, as it suggests a lack of confidence among traders in the rebound. However, it is important to note that this is not a strict rule.

Dead Cat Bounce Pattern Strategy

Bearish Dead Cat Bounce Pattern

  • The sell signal is generated when the currency pair’s downward movement has been excessive, and a rebound appears to be likely.
  • The sell signal is triggered when the currency pair starts to move upward but fails to break above the previous high.
Bearish Dead Cat Bounce Pattern
Bearish Dead Cat Bounce Pattern

Dead Cat Bounce Pros & Cons

Pros

  • The dead cat bounce pattern is a simple and easy-to-identify pattern that can be used by traders of all skill levels.
  • Seller may have a high probability of hitting tp’s during the dead cat bounce.
  • The pattern can be used to quickly identify potential trend reversals in the Forex market.

Cons

  • It is not used by most of the professional traders and analyst thus there is a limited information about its profitability in the forex market.

Conclusion

The dead cat bounce pattern is characterized by a short-lived recovery during a prolonged downtrend, followed by a return to the downward trend. Trading strategies based on this pattern can be challenging to apply, due to the complexities involved in identifying and confirming the pattern. Additionally, trading forex market that have experienced a dead cat bounce also requires a high level of attention to detail. Despite these difficulties, the dead cat bounce pattern offers numerous benefits, particularly for short sellers.