What is Dead Cat Bounce?

Dead Cat Bounce is a type of bearish pattern that we can see in traditional and cryptocurrency markets, which is well known for being a “trap pattern” where many newcomer traders fall into what is known as a “dummy rally”. . 

Chen we talk about a Dead Cat Bounce or Dead Cat Bounce, we are talking about a trading pattern that indicates a temporary recovery in the prices of a token or cryptocurrency in the markets. This pattern is usually seen at times when an asset undergoes a marked downtrend, with an attempt to recover (in reference to the Dead Cat Bounce) and then the continuation of the downtrend.

Dead Cat Bounce's name comes from the idea that even "a dead cat" can bounce if it falls fast. Usually at times like these, many people with little trading practice fall for the false recovery signal when they buy tokens, and in the end the downtrend continues causing them to quickly fall into losses.

Meaning of a Dead Cat Bounce

When you are facing a Dead Cat Bounce, what you see from a technical analysis perspective is a continuation pattern of the preceding downtrend. Generally, during that brief price increase (false rise) you usually see a strong buy candle that ends briefly and is known as a "fool's rally". At this point, many novice traders often enter thinking that the bear market is over and a major move higher will follow, so they look to enter at that low price for profit.

The problem is that the amount of purchases is still negligible compared to sales, and once the buying force is exhausted, the sales force continues to plummet the price rapidly. At this point, you usually see a bearish candle that can be more or less pronounced, driven many times by those who have just entered and see that the price continues to fall below the price at which they have bought (causing the dead cat).

This pattern is quite difficult to see ahead of time unless you are keeping an eye on market strength (buy). If the market buying force falls rapidly into a rally, you may find yourself facing a Dead Cat Bounce and it may not be the best option to enter at that time. In such cases, it is best to see a lateral consolidation of the market (that the price of the cryptocurrency stabilizes in a lateral range) to then make the decision to enter it.

A very high risk opportunity

Some high frequency traders (those who tend to work on 1 to 5 minute candles) tend to enter at this time. For them it is, enter, exit and take profits. A strategy that is generally accompanied by leverage and Stop Limit type orders. However, it is very important to bear in mind that this is a high-risk operation. For example, if there is a very sudden price change and the Stop Loss or Stop Limit order does not jump, you could lose absolutely everything.

Example of a Dead Cat Bounce

The following screenshots will allow you to see two clear examples of a Dead Cat Bounce. In our first case, we are examining the BTC / EUR pair within Bit2Me Trade. There, we can see (in 15-minute candles) as a downtrend, suddenly it is broken by a bullish candle (which lasts 15 minutes) and that immediately follows the previous downtrend until the movement of the value is lateralized.

In this case, the Dead Cat Bounce barely lasts 15 minutes, but if a trader has entered that zone, he has started to lose with the following candles. Although this example is of a very short duration, it gives us an idea of ​​these types of patterns and their duration.

In the second, we can see a slightly more pronounced Dead Cat Bounce pattern. We see how the downtrend is marking little by little, until there is a group of bearish candles. However, there is immediately a price rally that lasts for several candles (again in 15 minutes). At this point, several have surely entered the market with a strong buy thinking about the subsequent rebound.

Despite this, when the purchasing force ends, sales exceed it and the fall in price continues. This new decline is driven by those who have bought only a few minutes ago and who have waited for the bullish consolidation.

Recommendations before this signal

As we have said, a Dead Cat Bounce is a "rally for fools" and can only be clearly observed once it has started. In such a case, some recommendations to avoid falling before this type of false bullish signals are:

1. Use tools that analyze market strength. Indicators such as RSI and Stoch RSI, can give you a clear idea of ​​the market strength at that moment and act accordingly. While this is not 100% foolproof, it is better than rolling dice and gambling.
2. Check the depth of the market. Perhaps one of the most forgotten (and little understood) tools for novice traders is the depth of market. Keeping an eye on it can indicate if the market is really changing its long-term trend. Or, if, on the contrary, the "rally of fools" has only begun. In any case, the depth of market is available in real time and provides a lot of information. Especially, about what is going through the minds of the other traders who participate in it.
3. Wait for the market to consolidate. If you are not an expert trader and you do not trade in high frequency, it is best to wait for the trend to consolidate. At that time you can buy or sell, according to your needs.
4. Prepare your Stop Loss or Stop Limit. If you enter a market with the possibility of a Dead Cat Bounce, always keep in mind to use Stop Loss or Stop Limit orders. Thus, in case of falls, you can minimize your losses. Keep in mind that the limit of your loss must be well configured. In liquid markets, a limit close to your purchase price (eg: € 25 below the purchase price) may be a good idea. But in markets that are not very liquid or with a very high variation, this differential must be greater. This is because in the end there may not be time or liquidity to complete your order and you will be at a loss for it.
5. Do not leverage yourself without knowing what you are doing and less in moments where a Dead Cat Bounce may appear. The chances of losing everything are too high.
6. If all of the above fails: patience and HODL. If you operate with a high demand cryptocurrency or token (such as BTC or ETH) and you do not want to lose, it is best to keep it and create another strategy to win (ex: put a sell limit order with a desirable future sale price, in whichever you win). In any case remember, you do not lose until you sell, because the value of your cryptos in the end can be much higher than what you bought.