The aftermath of a major market event can be just as important as the event itself. For example, you might see a brief rebound known as a Dead Cat Bounce after a stock crash. This is when the price of a stock, security, or index rises shortly after declining sharply. This may signal an opportunity to buy at a better price in the future. However, if you are not careful, this brief rebound can fool you into thinking everything will be alright when it may signal an even bigger correction. This article will look at what causes a dead cat bounce and strategies for dealing with the aftermath of such an event.

What is a Dead Cat Bounce?

A dead cat bounce is a small, temporary recovery in the price of a falling stock. It's been called "the fabled dead cat bounce" because of its frequent association with falling stocks. It's also known as a short-seller bounce or short squeeze because it often results from aggressive short sellers betting on declining stock prices. A dead cat bounce happens when an investor misreads market sentiment and sells a stock at a low price. When the stock rebounds, they buy it back cheaper than they sold it, giving them what is colloquially known as a "dead cat bounce" in their portfolio. This can be seen as a subversion of good intentions—because even though the investor profits from this transaction, the company suffers from having sold more shares than necessary.

Why do they happen?

Dead cat bounces occur because short sellers tend to be aggressive in their bets that the stock price will fall. When a stock price drops to a level where they believe they can buy the shares back at a lower price, they buy them aggressively and push the price up. The price increase may be significant enough to cause other investors to buy the stock, pushing the price higher again. When short sellers buy many shares, the stock price will increase. If enough short sellers buy shares to push the price back up to the level before they sell the stock, they may be willing to exit their positions. This selling pushes the price back down, thus completing the cycle. If enough short sellers buy shares to push the price back up to the level before they sell the stock, they may be willing to exit their positions. This selling pushes the price back down, thus completing the cycle.

Detecting & Avoiding Dead Cat Bounces

You can detect a dead cat bounce by watching the stock price compared to volume. If the price goes up, but the volume stays the same or goes down, it's a dead cat bounce. Suppose there is a volume increase that corresponds with a price increase. In that case, the price increase is likely caused by a change in market sentiment rather than by short sellers. Avoiding dead cat bounces requires looking for stocks experiencing a significant sentiment change. Suppose a stock's price is increasing, but the volume is also increasing. In that case, it could be due to a positive change in outlook for the company. A stock that has been declining for a long time may see a sudden increase in volume as short sellers rush to cover their positions. This could be a sign of the stock's increasing price. If you see these indicators, you can buy the stocks and wait for them to go back down. Then, you can sell them at a higher price. However, you will want to ensure you understand why the price change occurs. If it is just a dead cat bounce, you will lose your profit when the price returns to normal.

Diversification Strategies for Dead Cat Bounce Events

Diversification is the process of spreading your investment over several different assets or types of assets. This can be an effective strategy to minimize risk. It is important to remember that diversification does not promise to eliminate risk but to lower it. One type of diversification that is often overlooked is diversification between different tokens. In the current market, it is common to find an exchange that offers hundreds of different tokens. There is a good chance that the tokens you own are correlated to the broader market. Buying a few other tokens, even unrelated ones, can reduce your portfolio risk.

Strategies to Turn a Dead Cat Bounce Into a Long-Term Opportunity

Suppose you believe a dead cat bounce event is a rebound and want to turn this into a long-term opportunity. In that case, you can use a few strategies to take advantage of the situation. The first strategy is to buy and hold. This is a tried and true strategy for long-term investors. The second strategy is to dollar cost average. This strategy involves buying slowly over time to average out the price. The third strategy is to use a combination with other strategies. While these strategies are effective, it is important to note that the cryptocurrency market is highly unpredictable. Just because something is cheap now does not mean it will be cheap in the future. There is a chance that the correction will correct itself, and the token will become more expensive than it was before.

Conclusion

Dead cat bounces are a normal part of stock trading, and you will likely experience a few in your lifetime. The best way to avoid them is to use volume data to ensure a significant price increase. If it is, it is more likely that a fundamental change in the company's outlook caused the price increase rather than aggressive short sellers. If you see a significant increase in volume and a corresponding price increase, it may be a sign that the stock is about to break out and start trending up. At that point, you can sell your shares for a profit. The aftermath of a major market event can be just as important as the event itself. For example, you might see a brief rebound known as a dead cat bounce after a stock crash. This is when the price of a stock, security, or index rises shortly after declining sharply. This may signal an opportunity to buy at a better price in the future. However, if you are not careful, this brief rebound can fool you into thinking everything will be alright when it may signal an even bigger correction.

Suppose you believe that a dead cat bounce event is actually a rebound. In that case, you can use a few strategies to take advantage of the situation. It is important to remember that diversification does not promise to eliminate risk but to lower it.