2023-04-03 • Updated
Introduction
Imagine that you trade your favorite currency pair in the long-lasted bear market. Suddenly, the price has started to go up. However, don’t get confused too quickly. There is a possibility that you faced with a so-called dead cat bounce. Wait, don’t be scared, FBS carries about animals and the environment! This is just the name of the short-term retracements. But they may actually be “deadly” for you, especially if you do not know how to trade during this situation and how to divide such bounce from the actual reversal. In the article, we provide you the explanation of the dead cat bounce and the trading strategy, which may be used to trade during this kind of reversal.
What is a dead cat bounce?
The meaning behind this phrase is simple: even the dead cat may bounce if the speed is fast enough. The term “dead cat bounce” is used when the market rebounds within a prolonged downward movement. However, such a rebound usually lasts for a short period of time and bears take over the market very quickly. While the market goes up and down, different forms of retracements are always possible. That is why these situations may be used by some smart traders to earn money.
Spotting a dead cat bounce
At first, you need to divide such rebound from an actual reversal. Here's the brief instruction on how you can do it.
The strong bearish trend usually lasts for a long period of time. You can learn how to define a downtrend here.
If there is an important announcement by the central banks (Fed, for instance) or there is any crucial news during the downtrend, the possibility of a dead cat bounce’s appearance is likely.
There are several trend indicators which may help with identifying the current direction of the price. They include parabolic SAR, Bollinger bands, standard deviation, ADX, and moving averages. You can find out how to apply them correctly from the Forex guidebook.
Sometimes oscillator indicators may signal the reversal, too. For example, if RSI falls into the oversold zone, we can expect the price to go up.
If some of these conditions are not met, then you are probably facing the fake reversal, known as a dead cat bounce.
Trading a dead cat bounce
When you identify a dead cat bounce, you need to open a short position when the pair breaks the last bottom level before a dead cat bounce. It’s highly important to pay attention to the price moves, as you may skip the right time to enter the market.
Below we pointed out the trading strategy with a dead cat bounce.
Example
Let’s look at the 4-hour chart of EUR/USD. Here we can see, that the price for the pair went up, despite the downtrend and broke the trend line. In addition, that parabolic SAR did not signal a reversal as well as Bollinger bands. RSI was placed in the middle, which also might be interpreted as the continuation of the trend. After the pair fell below its last low at 1.1499, a dead cat bounce was confirmed and we could place a short order at this level. At the same time, we placed a stop-loss order above the last high at 1.1541.
Be aware, that you may face an actual reversal. On the daily chart of AUD/USD below, you can see that the jump of the price occurred. However, despite the bearish candlestick which was formed after the rise and pulled the pair lower than its previous bottom, the market changed the trend. If we look at RSI, it fell close to the oversold zone. That is why we recommend you to analyze your further steps in the market more thoughtfully. In case you opened a short position, the stop loss placed above the top at 0.7069 would save you from an unfortunate outcome.
Note: The phrase “time is money” is very suitable for this kind of strategy. If you do not enter the market at the right time, you will probably miss a great trading opportunity.
Conclusion
A dead cat bounce may be tricky, that is why you should trade during this situation very attentively. The main advice you need to follow is to be patient and wait for more confirmations on the chart.
Sometimes a chart or a candlestick pattern may provide a decent entry signal if it is located at a certain level. A pin bar is one of the most reliable and famous candlestick patterns, and when traders see it on the chart, they expect the price to change its direction soon.
Among hundreds of different indicators and technical tools for traders, the relative strength index (RSI) is one of the most popular due to its simplicity and, at the same time, its power in various trading cases. In this article, we want to tell you about another powerful tool similar to RSI but with some cool tweaks.
There are a lot of valuable strategies that require the knowledge of candlestick patterns and oscillators. However, not of them are profitable. When you start trading with them, you can face situations when the strategy is not moving your way.
If you are 18+ years old, you can join FBS and begin your FX journey. To trade, you need a brokerage account and sufficient knowledge on how assets behave in the financial markets. Start with studying the basics with our free educational materials and creating an FBS account. You may want to test the environment with virtual money with a Demo account. Once you are ready, enter the real market and trade to succeed.
Click the 'Open account' button on our website and proceed to the Trader Area. Before you can start trading, pass a profile verification. Confirm your email and phone number, get your ID verified. This procedure guarantees the safety of your funds and identity. Once you are done with all the checks, go to the preferred trading platform, and start trading.
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