How to Spot a ‘Dead Cat Bounce’ + Strategies to Trade It

This forms an area of support where the price can bounce to, should it dip again near that price level. The chart above shows a bluechip stock that encountered heavy selloff after the overall index crashed due to the pandemic crisis. Observe how the price sharply bounces when the RSI goes below 20. A fundamentally robust stock going below the RSI https://traderoom.info/trading-the-bounce-from-sr-levels/ 20 level is a strong buy signal. Oftentimes, major institutions will quickly buy up the price causing the price to shoot back up.

For example, if a stock hits a certain support, you might be so overconfident and decide to place a big trade. When it happens, it can lead to a big loss when the price continues falling. A trend reversal is a situation where an asset moving in one direction changes and starts moving in another one. In this case, if a stock is falling, a reversal happens when it resumes the upward trend.

This can lead to a strategy that doesn’t work in real trading conditions. To avoid over-optimization, use out-of-sample data to test your optimized strategy. Once you have backtested your strategy, it’s time to optimize it. Optimization involves changing the parameters of your strategy to find the combination that yields the best results. The parameters you can optimize in the Bid-Ask Bounce strategy include the number of bars to look back, the threshold for entry, and the stop-loss level.

How to Trade Dead Cat Bounces

The following tutorial uses the DAX futures market, but the same steps can be used on whichever markets you are trading. The trading example used here is a short trade, using one contract, with a target of 20 ticks, and a stop loss of 10 ticks. The default trade uses a one to five-minute open, high, low, and close (OHLC) bar chart, and the daily pivot points. Traders can then automate trades or follow and execute them manually.

In this report, we will look at two recent examples of a dead cat bounce. As soon as your entry order has been filled, make sure that your trading software has placed your target and stop-loss orders, or place them manually if necessary. To do well, you need to make smart moves and use different strategies depending on the situation. One common strategy in trading is called the Dead Cat Bounce, even though the name might sound a bit grim.

1. In the context of this post, we will stick to daily time frames and illustrate standard Bounce Play patterns for the purpose of familiarization.
2. In the chart below, we see that the price of crude oil was in a downward trend.
3. This signal happens when the indicator (usually the RSI) is making HIGHER lows while the price action of the stock is establishing LOWER lows.
4. The pivot point bounce is a trading strategy or system that uses short timeframes and the daily pivot points.
5. Backtesting involves testing your strategy over historical data to see how it would have performed in the past.

After a stock bounces from a major downtrend, the price will likely retest the support area to validate the strength of the buying pressure. As more buyers come in, another bounce is triggered and eventually propels the stock price to break its initial resistance. The chart above shows a typical bounce formation at a key support level. The initial bounce last December 2019 at 1.00 php validates the support level. The price retraces back to this level on March 2020 and is again met with a strong demand in buying. Thus a second bounce formation formed creating what is called as a Double Bottom Reversal.

How to spot a dead cat bounce

This could mean two stocks in two completely different industries because stocks tend to share certain environmental biases and mostly go up and down together. It’s easy to break the rules when you’re sure you’ve found a “can’t-lose” trade. If you have a winning streak and your account grows to $12,000, your maximum portfolio risk increases to $600. While the 3% rule protects you on individual trades, the 5% rule safeguards your entire portfolio. The 3% rule directly impacts your position sizing and stop-loss placement.

On which markets can the market profile indicator be used?

Choose the Right Securities Not all securities are created equal, and some are better suited for bid-ask bounce trading than others. Look for securities with high liquidity and volatility, as these are typically the best candidates for this strategy. Pay attention to news and market events that may affect the supply and demand of a security. For example, a positive earnings report may cause an increase in demand for a stock, causing the bid price to rise. While optimization is important, it’s also essential not to over-optimize your strategy. Over-optimization occurs when you tweak your parameters too much to fit the historical data.

1. Wait for a fractal high to confirm and validate a decline in price movement from the resistance level.
2. Watch the market, and wait until the price has moved away from the moving average.
3. When it happens, it can lead to a big loss when the price continues falling.
4. For a short trade, the price bars should be making new highs as they move towards the pivot point.
5. For advanced traders, it can be a great strategy to make well-informed decisions and consistently position for profitable opportunities.
6. These levels are drawn horizontally when the Fibonacci tool is plotted on a defined price move.
7. Their importance is further underscored by the attention they receive from institutional investors.

However, like any other tool, it requires understanding and proper application. Utilize technical analysis tools such as charts and indicators to identify potential bid-ask bounce opportunities. For example, a trader may use a moving average to identify when the bid price has crossed above the ask price. On the other hand, Bid-Ask Bounce is a trading strategy that allows traders to profit from the Bid-Ask spread.

The market profile provides a detailed picture of actual buyer and seller activity, consolidating information about recent trades in a convenient format. This approach is advantageous compared to trading based on moving averages, which can cross at any moment if you change the period. Typically, this technique uses a small time frame and one type of Exponential Moving Average (EMA) to give more weight to recent price movements. EMA does have an advantage over other types of Moving Averages such as Simple Moving Average (SMA) and Weighted Moving Average (WMA). This is because EMA is much more responsive and suitable for various trading techniques, including the bounce strategy.

For example, if the potential profit from a trade is twice the potential loss, they can afford to risk more on the trade. The default trade uses a one- to five-minute open, high, low, and close (OHLC) bar chart and a 34-bar exponential moving average of the typical price (high, low, and close, or “HLC”). Both the chart time frame and the exponential moving average length can be adjusted to suit different markets. A moving average removes short-term fluctuations from a chart line, demonstrating an investment’s overall direction and trend. There is no way to know if the support level will hold until it either does or doesn’t. As soon as the price corrects from the bounce, the trader or investor will close the position.

This Forex concept is a discretionary method of trading and must be used along with other tools and analysis, specifically multiple time frame analysis. It can help us identify these levels by showing where the price of the asset tends to bounce off on the moving average line. The Rule is a risk management strategy designed to protect traders from catastrophic losses while helping efficiently capture gains. Alongside other volume analysis tools, ATAS provides its users with the market profile indicator that has numerous features. The next day, this level acted as resistance, offering traders an opportunity to initiate short positions. The Market Profile Indicator is a powerful analytical tool in the ATAS platform.