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When Does a Dead Cat Bounce?

29 August 2008 - Features - Editor

Stock exchange traders have developed a vocabulary that is very often only understood within the finance industry. Talk of bulls and bears and dead cats bouncing can be mystifying to outsiders. While a bull and bear market is fairly readily understood, what does “dead cat bounce” mean?

The term “dead cat bounce” is used in reference to a stock that experiences a dramatic downward spiral which is unexpectedly interrupted by a moderate, but temporary, rise before continuing with its downward movement. The moderate, temporary rise would not have been due to an improvement in the fundamentals of the stock, but would more likely have been in response to a change of some sort in the market. Based on the idea that “even a dead cat will bounce if it falls from a great height”, the stock that rallies briefly only to fall again, can be seen as dead stock.

It is believed that the first time the phrase was used was in 1985 when the Malaysian and Singaporean stock markets bounced back briefly following a drastic fall during the recession experienced that year. It was reported by journalist Christopher Sherwell of the Financial Times that a stock broker was quoted as saying that the brief market rise was a “dead cat bounce”. The phrase caught on and continues to be used today.

The reasons for a dead cat bounce are often technical, such as when investors have standing orders for the purchase of shorted stocks should they fall below a pre-determined level, or to cover specified option positions. When those pre-determined levels are reached, the buy orders kick-in resulting in a sudden rise in demand, which in turn results in a rise in the price of the stock.

Speculation can also cause a bounce. Some traders buy stocks that they believe are at the bottom of the market, anticipating a bounce which will allow them to make a quick profit. This strategy can, in fact, create and magnify a dead cat bounce.

In the current volatile market, whether a market rise after a sharp fall is a dead cat bounce or a genuine rise following the bottoming out of the market can only be determined over a period of days or weeks and with the benefit of hindsight – which is after all the only exact science.

 


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