A dead cat bounce in the forex, equities, indices, and the stock market is simply a bullish run in price in an overall bearish market. The reason it’s called a dead cat bounce is because investors and traders mistakenly think that the price of the asset they’re trading is recovering and is going to continue bullish, when in fact it’s only pulling back before continuing to break lower.
A great example of this is the price action that we’ve seen in 2022 starting with prices of the indices including the S&P 500 (US500), Nasdaq (US100), and Dow Jones (US30) dropping consistently since January of 2022, only to see a temporary recovery in mid-March and mid-July (dead cat bounce) before prices continued to fall and make new lows.
How To Use A Dead Cat Bounce In Forex
The dead cat bounce pattern isn’t just used by retail traders or institutions, you could aregue that this particular pattern can be used by anyone as it helps with getting a clear sense of market direction, especially when paired with using fundamentals to assess whether the price of an asset should continue bearish, or if it truly will see a reversal from a bearish trend into a bullish one.
Typically it’s best to look for short sell positions when price is in a bearish market, and to start looking for long positions when price has either started to respect a major low, or when it breaks a major low and starts to show clear signs of bullish intent in the form of an order flow shift or lower timeframe (4H, 1H, or 15M) break of swing structure.
More often than not, dead cat bounces occur when price has fallen quite rapidly as a result of after a long bull run.
Dead Cat Bounces Happen In Long-Term Bearish Markets
Dead cat bounces often occur in markets where prices of a particular asset, or even asset class start to fall rapidly either due to the fundamentals or because of a bubble. In cases where prices have over-extended to the upside we’ll sometimes see price start to retrace rapidly as investors and traders start to liquidate their positions out of fear of losing money.
When prices start to make a clear shift from bullish to bearish in the form of a break of structure, this is the ideal time to start shifting your bias and to start looking for shorts, while keeping an eye out for demand levels to the left that could be the catalyst for creating a dead cat bounce (temporary bullish price action).
This way, you’re able to captilize on taking shorts, as well as capitalize on taking longs when in an actual dead cat bounce pattern.
How To Use A Dead Cat Bounce Patterns As A Confluence
While we don’t necessarily trade directly off of dead cat bounce patterns in the forex market at Phantom Trading, we do recognize them as overarching patterns that have a significant effect on long-term market direction no matter what market we’re trading.
In certain markets with less liquidity, dead cat bounces can occur quite rapidly (within the period of a week or even a single day) when an asset pumps up high and subsequently dumps as buyers try to hold prices from dropping further, but in the forex and equities markets, we tend to see dead cat bounces develop over a longer time horizon as investors and institutions offload positions.
As mentioned previously in this article, the best way to anticipate and captilize on a dead cat bounce pattern is to simply wait until orderflow shifts on the mid-to-higher timeframes (15M, 1H, 4H, 1D), so you don’t get caught trying to call the start of the bounce, and so you also aren’t left holding the bag when the dead cat bounce inevitably continues to break in to lower prices.
Dead Cat Bounce Patterns In Conclusion
Ultimately, dead cat bounces can be seen as natural ebbs and flows within a bearish market, no matter what market you’re in. Dead cat bounces can also provide unique opportunities to both capitlize on sells and buys in that market, much like you would in an otherwise bullish market.
At Phantom Trading we try to employ a diverse range of tools and interpretations of the markets in order to approach them in a holistic way and increase the accuracy of our analysis and in turn extract better returns out the markets.
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Robert Castillo @coldwaterfx FX Trader & Analyst Writer & Editor
Rob is a funded trader from Toronto, Canada, and has been trading currencies, commodities, stocks, and cryptocurrencies for over 7 years. Outside of trading, he enjoys making music, boxing, and riding motorcycles.
