Dead cat bounce trading strategy

How to Day Trade the Dead Cat Bounce Strategy.

A swift drop followed by a light rally. Don't be fooled. Capitalize.

A stock just gapped down more than 5% on the open, relative to the prior closing price, and is continuing to fall. Soon the stock is down 8%, but then it starts to rally. Some investors who were thinking about buying the stock the prior day jump in, thinking the stock is a bargain at a 5% to 8% discount. Day traders who went short very early in morning cover their short positions, helping to fuel the bounce. Soon the price is back near where it opened, but still down 5% on the day. The price then plummets lower once again, as those who hadn't yet sold their shares yet are relieved to do so near the opening price.

This is a dead cat bounce. Here's how to make money on it.

The Dead Cat Bounce Explained.

In order for a dead cat bounce to occur, a stock must gap lower by 5% or more. 5% is just a guide. Basically, we need the open price to be much lower than the prior close. If a stock is always volatile, the gap should be bigger, if it isn't a volatile stock, then an approximate 5% gap down deserves attention.

The price must continue to decline for at least 5 minutes after the opening bell, preferably longer. Once again this is a guide, but we do need the price to continue falling after the open. If the price doesn't keep falling after the gap down (open), then we can't have a dead cat bounce and therefore this strategy doesn't apply.

Such drops are usually due to fundamental news that came out overnight, such as an earnings release.

The dead cat bounce trader watches the price fall, and when it starts to bounce they get ready to go short.

Why short? Because the "cat is still dead." Just because the stock bounced doesn't mean it's going to keep surging. Significant damage was done to the stock price and investors are scared. A bounce is a second chance for those scared investors to unload shares, pushing it lower. Day traders should watch for this, and capitalize on it.

Continue to 2 of 3 below.

When to Go Short.

A dead cat bounce is when the price gaps down 5% or more, continues to decline after the open, but then has a rally.

Watch for the price to rally back into the vicinity of the open price. The area around the open price is likely to be a resistance level. This is once again a guide. We want the price to come within a couple percentage points of the open price, it may stay below or it go just above, but once the price enters the vicinity of the open price we are on high alert for taking a short position.

Take a short position only once the price starts to drop again. By waiting for the price to start dropping, after nearing the open price, the day trader has more confirmation it actually is a dead cat bounce.

Using the Finviz stock screener, choose Signal: Top Losers , to see the stocks which have gapped down in the morning. Upgrade to Elite Finviz for real-time quotes and pre-market data (very useful for this strategy). Set Average Volume to at least 500,000 or 1,000,000 to assure all the stocks generated on the list have adequate volume for day trading.

Continue to 3 of 3 below.

Stop Losses and Price Targets.

Dead cats that bounce eventually return to where they bounced from. While no strategy works all the time, if the price respects the open and declines off of it, it will often retest the low price created before the bounce (morning low). Therefore, the initial price target for the short position is just above the prior low. Ideally exit part of the position there.

Click here for larger image of trade example.

If the price starts to rally again, exit the rest of the position. Or, if the price breaks below the low of the day, hold onto the remainder of the position and exit at the first sign of a bounce. A tight trailing stop works well in this situation.

When the short position is taken, place a stop loss several cents above the recent high which occurred just before you went short. Remember, we are waiting for the price to turn lower, which means there must be a high point above our entry price before we enter. This stop loss is a guide so making slight adjustments is acceptable.

Mainly, the stop should be out of reach of normal fluctuations, yet still keep risk controlled and allow the profit potential of the trade to outweigh the risk. Shoot for trades that offer at least a 2:1 reward to risk ratio. If the stop loss is $0.50 from your entry price, then the first target should be $1 or more below the entry price, based on the guidelines above.

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Wednesday, May 28, 2014.

Day Trading The Dead Cat Bounce Pattern; SchoolOfTrade.

the candle of the news that we have to measure it form high to low or from low to high, usual the rang of it suppose to be how many ticket.

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Trading a Dead Cat Bounce.

Extremely volatile markets create an environment for the formation of a very specific type of technical price pattern. The “Dead Cat Bounce” pattern (DCB) may have a macabre name but it comes with very nice profit potential and is relatively easy to identify.

At its heart the DCB is a great study in investor psychology. It occurs when investors have panicked or have been caught by surprise which is why the pattern occurs most frequently in bearish and volatile markets.

[VIDEO] Dead Cat Bounce, Part 1.

Investor psychology comes into play because traders are likely to become fearful at the same price levels that they have been fearful before. We use the DCB to identify those price levels for potential breakouts.

The pattern consists of a gap during a downtrend when prices have moved between the close of one day and the open of the next trading day. The larger the gap is the more significance technicians will assign to the pattern. The gap is typically created by unexpected news appearing after or before normal market hours.

The gaps indicates that traders have “overreacted” to the data, the stock is likely to become oversold at some point and will begin to retrace back towards the gap. The top and bottom of the gap will act as resistance barriers and if the market or stock peels off of these resistance levels, the subsequent decline can be quite significant.

The rally back towards the gap is a good example of a bull trap and the final decline that completes the pattern can be larges and fast as a feedback loop of stop losses push more sellers into the market.

Example of a dead-cat-bounce.

In the chart above you can see a DCB that formed on Goldman Sachs (GS.) Once a breakout to the downside occurs, shorts enter the market. Buying puts at this point is a great way to limit your risk while still taking advantage of the downside potential.

In the video, I will cover the pattern in more detail with a few additional examples. In the next article in this series I will show you how you can project price targets once the pattern has completed itself.

Forecasting a Dead Cat Bounce.

Identifying a dead cat bounce is just part of the challenge. Estimating or forecasting the likely distance the stock will move following the pattern’s confirmation is also important. This is a challenge for technical analysts as much as it is for fundamental analysts. Creating an estimated profit target will help you make better decisions about the trading strategy you will use to take advantage of the price move.

[VIDEO] Dead Cat Bounce, Part 2.

There is a reasonably easy way to start making these estimates following the bounce back down from resistance. To do this we will be using fibonacci retracements, which are one of the primary tools used by technicians to identify support and resistance levels and to make price projections. The same technique you see in this article can be applied on many other technical patterns as well.

The image below illustrates how this analysis is conducted. A fibonacci retracement is drawn from the first bottom following the gap (point A) to the break down from resistance at the gap (point B). The retracement lines themselves can be ignored because what you are interested is past the first low at the 161.8% projection level (point C).

As you can see in the case study above this price was easily reached. Of course, ongoing trade management continues to be important but this analysis provides a solid starting point for evaluating the opportunity.

Based on the estimate you can decide how to best take advantage of the opportunity. A very tight profit target may be difficult to trade with a long option and a short call sold above resistance may be more attractive. Conversely a very long profit target could be ideal for a long option that retains unlimited profit potential.

Trading a technical price pattern is a three step process. First we identify the pattern and wait for confirmation. Second, the an initial price target estimate is produced. Third, using the information gathered in the first two steps you can select the right trade strategy and actively manage the position. Approaching an opportunity this way helps traders maximize a profit opportunity.

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Bulkowski's Dead-Cat Bounce.

Written by and copyright © 2005-2017 by Thomas N. Bulkowski. All rights reserved. Disclaimer: You alone are responsible for your investment decisions. See Privacy/Disclaimer for more information.

For more information on this pattern, read Encyclopedia of Chart Patterns Second Edition , pictured on the right, pages 829 to 843. That chapter gives a complete review of the chart pattern, compared to what is described below.

If you click on this link and then buy the book (or anything) at Amazon, the referral will help support this site. Thanks. -- Tom Bulkowski.

The numbers cited in this article are based on hundreds of perfect trades. See the glossary for definitions.

The dead-cat bounce is the name of this event pattern. Price makes a dramatic drop, averaging 30%, before bouncing only to resume the decline at a more leisurely rate.

Which industries are more likely to have stocks that dead-cat bounce? For the answer, click here.

Identification Guidelines for Dead-Cat Bounces.

Reference the above figure in the following table.

Dead-Cat Bounce Trading Tips.

I released a trading setup based on new research using a dead-cat bounce that may interest you.

Example Dead-Cat Bounce.

The above figure shows an example of a dead-cat bounce.

On July 5, 2001, a broker issued a report that said Amazon would beat the consensus estimate for earnings. It didn't. When Amazon announced earnings results on July 23, they were below expectations. Price gapped open and closed 25% lower. The next day, price made a lower low and then started a recovery. It bounced upward for about a week and then turned down. When price finally began a recovery, it had bottom 66% below the close the day before the earnings announcement.

Other Examples of Dead-Cat Bounces.

Here is a setup using a dead-cat bounce. Which industries dead-cat bounce the most? Here are the other event patterns. Selling tips. Here's a dozen selling tips every trader should know. Trade review. Reviewing trades can lead to profits. Factors influencing stocks. Find out how important trends are.

Written by and copyright © 2005-2017 by Thomas N. Bulkowski. All rights reserved. Disclaimer: You alone are responsible for your investment decisions. See Privacy/Disclaimer for more information. Never use a big word where a diminutive one will suffice.