If you have been following the stock market for awhile, you may have heard about a term called the dead cat bounce (DCB). This term that has been around for more than 25 years and seems to gain more popularity as the years pass. Dead cat bounce is a Wall Street term that refers to a small, brief recovery in the price of a declining stock or a small and temporary recovery in a financial market following a large fall.
The origin of the phrase dates back to the year 1985, in an article written by Chris Sherwell in The Financial Times commenting on the Singapore stock market. He wrote, "Despite the evidence of buying interest yesterday, they said the rise was partly technical and cautioned against concluding that the recent falls in the market were at an end. This is what we call a 'dead cat bounce', one broker said flatly."
When a stock or financial market suffers a consistent fall, many traders will try to detect what the stock's lowest price is and will start buying hoping that they are buying a bargain. This can happen with penny stocks often. If a penny stock has a sharp fall, chances are that many traders will swoop in and start buying, hoping that they are buying at a low. With so much buying pressure, the stock does temporarily rise but eventually can decline again. The temporary rise is called the dead cat bounce. The idea, as morbid as it sounds, is that even if you drop a dead cat from a roof, it will still bounce from a great a height.
When a stock declines, as much as 20%, it will eventually find its initial bottom and can rally for a short period of time afterwards. Savvy traders and investors trade dead cat bounces for quick profits while beginning investors may stay in the trade too long and will go down with the ship as the rally comes to an end. There are a few reasons why inexperienced traders can lose significantly playing these bounces, which include: 1. They stay in the trade too long due to greed and 2. They misinterpret rising volume as a bullish trend when it's a signal for profit taking. It's important to play dead cat bounces for fast immediate profits. If you see yourself with a profit, it is wise to take it and move on. Many penny stocks can give ample opportunities for dead cat bounce plays.