Dead Cat Bounce

The first part of the dead cat bounce pattern consists of a massive drop in prices (the average being roughly 31%), and is often accompanied by a large gap down (Bulkowski, 2005). This massive drop in prices is usually caused by an "event decline" which is usually a negative news story or earnings report (Kirkpatrick & Dahlquist, 2010, p. 372). The second part of the dead cat bounce pattern is the "bounce" portion, where prices move back up and can partially fill the gap or completely fill the gap. This bounce averages 28% high according to Bulkowski's research (2005) and occurs over 23 days. Kirkpatrick & Dahlquist (2010) emphasize that not all event declines have this bounce. The third part of the dead cat bounce pattern is the post-bounce decline. The low established by the event decline is penetrated below two-thirds of the time by this post-bounce decline and averages 18% below the prior event decline low (Bulkowski, 2005).

Kirkpatrick & Dahlquist (2010) suggest trading the dead cat bounce from the short side; once prices bounce off of the event decline bottom and begin to top out at the bounce peak, then the authors suggest short selling and riding prices lower. Bulkowski (2005) suggests buying to cover the short at the price level of the event decline low.

Average TimeSpans of Dead Cat Bounce and Price Movements

Average Price Movements of Dead Cat Bounce

Inverted Dead Cat Bounce

The inverted dead-cat bounce is not exactly the opposite of the dead-cat bounce. The quick summary is that if a trader owns a stock after a quick and large (5-20%) gain that is usually a gap up, then sell on the second day after the gap up day to lock in profits because prices usually begin falling thereafter before beginning a new move upward (Bulkowski, 2005).

Dead Cat Bounce Pattern Chart Example

The chart above of Krispy Kreme Doughnuts (KKD) illustrates a 52% drop from the close prior to the gap down to the event decline low. Prices then rally two-thirds of the distance back upward before the post-bounce decline moves downward once more. Prices do indeed break below the low of the event decline low, but only by 8%. As occurs occasionally, 26% of the time according to Bulkowski (2005), there is a second bounce which occurs in this chart.

Inverted Dead Cat Bounce Pattern Chart Example

The chart of Bed Bath and Beyond (BBBY) illustrates a gap up where the close price prior to the gap and the close price after the gap was a gain of over 24%. Selling the day after the gap day would have resulted in a little loss of the 24% gain, but would have prevented a three and a half month loss of the majority of the gains of the large one-day move upward.

Works Referenced

1. Kirkpatrick II, C.D., & Dahlquist, J.R. (2010). Technical Analysis: The Complete Resource for Financial Market Technicians (2nd ed.). Upper Saddle River, NJ: FT Press.
2. Rockefeller, B. (2011). Technical Analysis For Dummies (2nd ed.). Hoboken: John Wiley & Sons.
3. The Pattern Site. (2008). Bulkowski's Measure Rule. Retrieved June 1, 2012, from http://thepatternsite.com/measure.html
4. The Pattern Site. (2005). Bulkowski's Dead-Cat Bounce . Retrieved June 1, 2012, from http://thepatternsite.com/dcb.html
5. The Pattern Site. (2005). Bulkowski's Inverted Dead-Cat Bounce . Retrieved June 1, 2012, from http://thepatternsite.com/idcb.html