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Bulkowski's Trading the Inverted Dead-Cat Bounce

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Written by and copyright © 2005-2019 by Thomas N. Bulkowski. All rights reserved. Disclaimer: You alone are responsible for your investment decisions. See Privacy/Disclaimer for more information. Some pattern names are the registered trademarks of their respective owners.

Inverted Dead-Cat Bounce: Summary

Lessons are learned the hard way, and I am going to share one with you now. I think it's like telling a boy not to touch a hot stove. "You're gonna get burned..." you warn, but he touches it anyway.

The lesson is simple. If a stock you own gaps up by 5% or more, sell it the next day. That event pattern is called an inverted dead-cat bounce, and I am finding it to be one of the more reliable patterns. This article discusses a trade using that event pattern.

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For an in-depth analysis of event patterns, grab a copy of my book, Encyclopedia of Chart Patterns Second EditionEncyclopedia of Chart Patterns 2nd Edition book., pictured on the right. I discuss 10 event patterns, including the inverted dead-cat bounce, near the back of the book.

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Inverted Dead-Cat Bounce: Background Lesson

An inverted dead-cat bounce is an event pattern so named because it seemed to be the opposite of a dead-cat bounce.

The inverted dead-cat bounce occurs when a company announces news that sends the stock soaring by 5% to 20% or even higher. This event is not caused by takeover news because that event pattern shows a stock moving up and staying up. Rather, the inverted dead-cat bounce is often earnings related or because of positive results from clinical drug trials, patent dispute resolutions, legal awards, contract wins, oil patch discoveries, and so on.

After price spikes upward, it often drops back down within a week or two.

A frequency distribution of price movement over time suggests that fewer than half the stocks make a higher high the day after the announcement, but you can place a limit order to sell at the prior day's high and see if it hits. You will want to day trade the exit, if you can, to maximize profits.

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A chart of J Crew (JCG) stock on the daily scale.

Inverted Dead-Cat Bounce: Trading J Crew

That is the lesson. Let's see how it applies to an actual trade.

When the Obama administration took office in late January 2009, I remember Mrs. Obama getting press for liking J. Crew clothing, but I dismissed it. Then in April, I heard the news stories again while exercising on my treadmill. I thought, "The company is going to have a good quarter because of the publicity." So, I bought the stock as the chart shows (daily scale).

Not shown is that the stock had broken above a congestion area setup by a three peak formation in December 2008 (think triple top or head-and-shoulders top). After that, I held onto the stock.

Fast forward to May 28. I show that as point A on the chart, the day before price gapped up. The company reported quarterly earnings after the close. Profit dropped a massive 33%, but the company predicted profits in the next quarter instead of a loss the street was expecting.

The next day, price gapped open higher. A day later, sell day (B), I thought about this situation and decided to hold. I thought the rise had legs, meaning it would continued moving up in the coming days. That happens sometimes, not from better than expected earnings, but most often from future guidance by the company, as in this case.

As you can see, holding was a mistake. I eventually sold and made 65% on the trade, but I could have done better. I sold at 25.296 but the day after the event (B), the stock ranged from 25.90 to 27.94. After I sold, the stock bottomed at 22.58.

The moral of the story is this: If the market gives you a gift, take it and run before it snatches it back.

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Inverted Dead-Cat Bounce: The Conseco Trade

A picture Conseco (CNO) on the daily scale.

When price climbed out of a congestion zone, I bought and received a fill at $1.64. I forgot about the earnings report. My intent was to hold the stock for the long term, to see it climb from 1.64 to 17 or even 25.

Each day price seemed to climb but I did not focus on it. If the stock market did well (which I expect), then the stock would also. Why? Because insurance companies take their outrageous premiums they charge you and me and invest it in the stock market. If their investments rise, the worth of the company rises and the stock should follow.

When I looked at CNO this morning (Monday 5/11/2009). It did not dawn on me that the stock had gapped up 45% (from yesterday's close of 2.69 to a high so far of 3.90). Then I went searching for the reason for the gap. Earnings. The company announced earnings this morning, something that I forgot about. Fortunately, they were better than the market expected.

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Inverted Dead-Cat Bounce: The Sale

Knowing that I bought the stock at $1.64 and it was now at 3.50 and dropping, I decided to pocket my winnings. I sold it and received a fill at $3.47.

Here are my reasons for the sale.

  • The likelihood of price dropping exceeds the upside short-term potential
  • I doubled my money in 6 days! Yippee!

Over the coming months, the stock never posted a higher high (as of July 22, 2009) and dropped to a low of 1.68 on June 17, 2009, about a month after I sold, dropping back to near my buy price.

Other Inverted Dead-Cat Bounce Examples

Other stocks in 2009 have made inverted dead-cat bounces. Here is a small sample.

  • Bed Bath and Beyond (BBBY) on 4/8/2009. Earnings release.
  • Bed Bath and Beyond (BBBY) on 6/25/2009. Earnings release.
  • Charlotte Russe Holdings (CHIC) on 4/9/2009. Earnings release.
  • Conseco (CNO) on 5/11/2009. Earnings release. I blogged about this trade. Here is the full text.

-- Thomas Bulkowski

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See Also

Written by and copyright © 2005-2019 by Thomas N. Bulkowski. All rights reserved. Disclaimer: You alone are responsible for your investment decisions. See Privacy/Disclaimer for more information. Some pattern names are the registered trademarks of their respective owners. Zeus said to Narcissus, "Watch yourself."