What is a Dead Cat Bounce?
To be a successful cryptocurrency trader, you need to master both fundamental and technical analysis. While most traders know that fundamental analysis is based on assumptions, they tend to trust the analysis. Technical analysis can also be misleading, especially when it comes to charts.
This guide will explain what a dead cat bounce is, how it works and why it happens. Hopefully, by the end of it, you will be able to recognize it whilst trading and make decisions accordingly.
How to identify a Dead Cat Bounce in the crypto market
Cryptocurrencies are assets known for their price volatility. This is what makes them great for short-term trading. As soon as the market trend changes, opportunities arise. However, while it’s relatively easy to trade during the bull market, the situation is different when the bear market arrives. Of course, there are still opportunities within a bear market, but they also present a lot of traps.
When assets suffer a prolonged decline, or their prices drop in the bear market, they sometimes see price reversal. It comes suddenly and allows the price to head back up, often rather sharply. This is where greed kicks in among inexperienced investors, as they head over to exchanges to buy into the asset. However, just as suddenly, the price heads back towards the lows and often go on to create lower lows.
When price behaves in this way, we call it the dead cat bounce in crypto.
To put it simply, it’s a downtrend interrupted by a brief recovery period. However, this price reversal is misleading. Experienced traders and investors know how to identify them, but many newcomers see it as an opportunity.
Can you recognize a Dead Cat Bounce?
The dead cat bounce falls into the category of a continuation pattern within the world of technical analysis. It often has multiple bounces, where the first one may seem like a market trend reversal. However, the price quickly starts going back down, revealing the pattern of a dead cat bounce.
A dead cat bounce only becomes official when the price drops below the prior low. Downtrends are frequently interrupted by short-lived recoveries and even small rallies. These can happen when traders or investors close out short positions. Some also start buying if they believe that the price has reached its bottom.
In other words, you cannot identify a dead cat bounce whilst it’s forming. You can assume that price movement may be a dead cat bounce, but there is no definite way to know. At least, not until the value drops again, and breaks its previous price support.
This is why investors and traders are always suspicious of sudden recoveries. They know that, in crypto trading, a mid-bear market recovery is likely a dead cat bounce.
What are the limitations of identifying a Dead Cat Bounce?
As mentioned, you can only truly recognize a dead cat bounce in crypto after it happens. With that being the case, traders are never sure whether the market trend is truly changing. Assuming the price suddenly goes up, they might think it is a dead cat bounce. If it turns out to be a real recovery, they might miss out on potential gains.
How does a Dead Cat Bounce occur?
Earlier, we briefly mentioned that a dead cat bounce could happen when traders close out short positions. The same could be said when traders start buying, as they believe the market has bottomed. The pattern happens as a result of short-term speculation.
If the short-term speculation attracts other investors, more and more liquidity is likely to enter the market. In exchange, the value of the asset is likely to increase. This will continue until traders start selling, which is when the price will continue its downtrend.
Another possibility is that sellers may exit their positions. This can also cause shifts in price action. Essentially, when a certain cryptocurrency seems overvalued, traders are likely to short-sell, as they expect the price to drop. As and When traders short an asset like this, it tends to lead to a flurry of buying, which attracts new buyers.
Can a Dead Cat Bounce be good for traders?
While dead cat bounces are generally perceived as a negative pattern, this doesn't have to be the case all the time. Ultimately, it’s only bad for those who invest during the bounce. If they are slow to get out, they can experience losses.
Experienced traders on the other hand, may profit from dead cat bounces. If they spot a dead cat bounce early enough, they can enter a trade whilst the price is rising then sell towards the top. Alternatively, they may decide to short the market towards the top of the dead cat bounce.
It’s therefore apparent, dead cat bounces aren’t necessarily good or bad. It’s simply a development in the market which you may or may not use to your advantage. It is risky, and requires skill and experience, but if you spend enough time analyzing the market, you could profit from these market structures.
Dead Cat Bounce: The final verdict
A dead cat bounce in crypto is a common occurrence during bear markets. It can also happen to an asset that has seen prolonged price drops, independent of the rest of the market. It’s a situation that can easily be misread, as there are no indicators that would suggest a market rally is actually going to become a dead cat bounce. The only way to know for sure is to wait for the pattern to happen. At that point, it’s already too late.
FAQs
Is a Dead Cat Bounce good?
A dead cat bounce is neither good or bad. It is a market situation that presents a high-risk opportunity. However, because of this risk, inexperienced traders are recommended extreme caution.
How do you know if a Dead Cat Bounces in crypto?
There is no sure way to recognize a dead cat bounce while it is happening. The only way to know for sure is after it has already happened. Any sudden increase after a prolonged drop can be just a dead cat bounce.
What happens after a Dead Cat Bounce?
After a dead cat bounce, the price returns to its drop. The drop may end soon after the price completes the pattern or continue for a longer period. But, for a pattern to be complete, the price must drop lower than at the start of the pattern.
Is a Dead Cat Bounce bullish or bearish?
A dead cat bounce tends to happen during the bearish market. However, the first portion of the pattern looks like a bull market. The second half then leads to bearish behavior again.
How long does a Dead Cat Bounce last in crypto?
A dead cat bounce can vary greatly in length. It has to be longer than a day, otherwise, it is just regular daily volatility. However, it can go anywhere from a few days to a few months in the extreme.
