Thursday, May 27, 2010
"Dead cat bounce" is a phrase describing the temporary and sometimes violent rally that occurs in an asset once it hits bottom. The farther the fall – the larger the bounce.
However, no matter how high the bounce, the dead cat will always fall back down and hit the bottom again. And there are two ways to trade it… We can trade the bounce, or we can trade the decline back to the bottom.
Stocks are primed for a dead cat bounce. The S&P 500 is down 15% or so over the past month. Investor sentiment, a contrary indicator, is overwhelmingly bearish. The S&P 500 is 60 points below its 20-day exponential moving average line (a distance of 30-50 points is extreme).
Tuesday's rally during the final hour of trading looked like it was the start of a bounce. But yesterday's last-hour reversal dropped the cat down a few more floors.
To be sure, it's tough to trade stocks from the long side right now. Every rally attempt is hit with selling pressure, and the news flow is decisively negative. Bullish traders need to be nimble and take profits quickly.
Nonetheless, there's a cat ready to hit the bottom. And when it bounces, it's going to be a whopper of a rally. After all, we're heading into the end of the month and it's a holiday weekend. Both of these periods tend to be bullish for stocks.
Over the next several days, the S&P 500 could rally back up to 1,100 or even 1,130 if the bulls really take control.
Remember, though, dead cats always fall back to the bottom. Once we get a bounce in stock prices, we're likely to come back down and retest the lows.
As a trader, I'm playing stocks from the long side right now. But I'll be quick to take profits and I'll be looking to short stocks aggressively if the S&P rallies back toward 1,130.
Best regards and good trading,
Fear index dips under 30… the VIX hits its lowest level in more than a week as stocks, commodities, and U.S. dollar all trade higher.
Discount store stocks all set fresh 52-week highs… Dollar General, Dollar Tree, and Family Dollar soar as plays on possible "double dip" recession.
Biotech behemoth Gilead sinks to fresh 52-week low… shares have quietly fallen 25% in three months.