Day traders who went short very early in morning cover their short positions, helping to fuel the bounce. Basically, we need the open price to be much lower than the prior close. The price must continue to decline for at least 5 minutes after the opening bell, preferably longer.
Once again this is a guide, but we do need the price to continue falling after the open. If the price doesn't keep falling after the gap down open , then we can't have a dead cat bounce and therefore this strategy doesn't apply. The dead cat bounce trader watches the price fall, and when it starts to bounce they get ready to go short. Because the "cat is still dead. Significant damage was done to the stock price and investors are scared. A bounce is a second chance for those scared investors to unload shares, pushing it lower.
Day traders should watch for this, and capitalize on it. Watch for the price to rally back into the vicinity of the open price. This is once again a guide. We want the price to come within a couple percentage points of the open price, it may stay below or it go just above, but once the price enters the vicinity of the open price we are on high alert for taking a short position.
Take a short position only once the price starts to drop again. By waiting for the price to start dropping, after nearing the open price, the day trader has more confirmation it actually is a dead cat bounce. Top Losers , to see the stocks which have gapped down in the morning.
Upgrade to Elite Finviz for real-time quotes and pre-market data very useful for this strategy. Set Average Volume to at least , or 1,, to assure all the stocks generated on the list have adequate volume for day trading. Stop Losses and Price Targets How to day trade a dead cat bounce. While no strategy works all the time, if the price respects the open and declines off of it, it will often retest the low price created before the bounce morning low.
Therefore, the initial price target for the short position is just above the prior low. Ideally exit part of the position there. If the price starts to rally again, exit the rest of the position. Or, if the price breaks below the low of the day, hold onto the remainder of the position and exit at the first sign of a bounce. A tight trailing stop works well in this situation. Updated October 14, This is a dead cat bounce. Here's how to make money on it. Stop Losses and Price Targets.
Final Word The key level in a dead cat bounce trade is near the open price of the original gap down day. Often the price will retest this level the same day, offering day traders a chance to get short. This level is often significant days and weeks into the future as well.
You may go short today, and the price falls, but a week down the road it may come back to test the same level--a second dead cat bounce. One to three dead cat bounce trades can result from a single gap down. Three dead-cat-bounce trades is the maximum for one gap, though.
Beyond that, it is best to look for other opportunities.More...