Dead Cat Bounce

The “Dead Cat Bounce” pattern is an event driven pattern that occurs due to some sudden, major event or news related events such as a corporate earnings report, merger, takeover, partnership, resignations/appointment and scandal; Federal Drug Administration (FDA) approval and Securities Exchange Commission (SEC) inquiries in a company. From the regular trading price pattern, price usually drops or rises at least 15% or more to indicate the seriousness and reaction to the event. As this condition emerges, traders enter a trade in the opposite direction of the event and trade a rise or drop about half of the event price change at some leisurely rate. This makes it a “Dead Cat Bounce Pattern”. Once the news settles, the price reverses the bounce and trades in the original event driven direction. This pattern has bull and bearish setups. This pattern also has high failure rate as some of these gaps are never retraced or filled for very long time.

Trade: It may be easy to trade the pattern once the “Dead Cat Bounce” occurs rather than chasing the event driven price-action. The rise/drop must be at least 15% of price. Most bounces are about 50% to 62% of the drop against the event-day direction. For an event driven price-fall, enter a short trade at 50% to 62% gap level. Short below the previous bar’s low. For an event-driven price-rise, enter a long trade at 50% to 62% gap level. Enter a long above the previous bar’s high.

Stop: Place a stop loss order at the event-days’ gap levels. For a short trade, place a stop at the high of the event-day’s gap down bar. For a long trade, place a stop below the low of the event day’s gap up bar.

Target: The target is placed about 100% of the gap range from the trade entry.

Trading Dead Cat Bounce Pattern

Trading Dead Cat Bounce Pattern

The example above shows a Dead Cat Bounce pattern from the Yahoo’s daily chart. Yahoo announced its earnings in late July 2006 and as a result its stock dropped from $3 1 to $25. From mid July to August 2006, Yahoo attempted to close the gap as it bounced back from $25 to $30. The gap range generated by Yahoo’s news was $4. In September 2006, Yahoo gave an opportunity to “short” at 50% level (at $29).

Enter a “short” trade below the previous bar’s low at 50% level of gap (at D:$28.50).

Place a “stop” order above the top of the gap at A (at $3 1.25).

Place a “target” at 100% of the gap range from the trade entry (at $24).

Trading Dead Cat Bounce Pattern

Trading Dead Cat Bounce (Upside) Pattern

The example above illustrates an upside Dead Cat Bounce pattern from the Infospace’s (INSP) daily chart. During August 2004, Infospace gap opened from $30 to $35. After a few sessions, Infospace retraced its rally into the gap. The gap range was $5. Infospace retraced about 50% of its gap range and presented a “long” trade opportunity.