The inverted dead cat bounce (IDCB) pattern involves a short-term price decline after a gap up or an increase in the price momentum after a downtrend. Prices begin on a lower low before rising to meet the gap up. The increase is caused by an earnings report or news that will first send the prices soaring before the decline. The trader can decide to sell short after the second day after prices hit a top resistance before they begin to pick again.
The IDCB occurs similar to the frozen rope pattern, where stock prices rise to form an angle, mostly 45 degrees, as it trends on a narrowing range. This range indicates a decline in the price volatility level to a multi-month low. At this point, the frozen rope takes after the dead-cat bounce as it initiates a nose-dive or a lower price move rather than a recovery. The IDCB will hit a short-term recovery as the price takes an upward trend.
- Prior down-trending price
Unlike the dead-cat bounce that starts from an uptrend, the inverted pattern begins from a downtrend. The price starts from below until the trader notices the gap-up.
Figure 1: Inverted dead-cat bounce on the Dominion Energy Stock
- Price decline after the earnings report
Good earnings reports say on a quarterly, or annual basis will propel the stock on a margin of 5-25% or further. The stock’s price makes a higher high in a 12-24-hour period. However, on the following day, the price starts declining before it rises again. If the asset takes a large-up move, it will be followed by a large-down trend.
Figure 1 shows the stock price trend of Dominion Energy, Inc. (D) in 2021. The energy company announced its unaudited net-earnings report on February 12, 2021, for Q4, 2020, and full-year analysis. The share price fell 3.63% from $73.63 to $70.93 on February 17, 2021. The trend line takes the shape of a near-frozen rope as it gains momentum on the sell and buy-side.
The dead-cat bounce was witnessed on February 17, 2021, after the price rose 3.4% from 70.93% to 73.46% the following day. Prices took a short decline to $70.35 on February 22, 2021, then proceeded with the nose dive from February 24, 2021, to March 5, 2021, when it hit a low of $67.84.
Figure 2: Depiction of the inverted dead-cat bounce pattern
Figure 2 shows that the dead-cat bounce formation occurs after two dead-cat bounce patterns kick in. The inverted form indicates a reversal of the downtrend. The trader will do well not to buy in a dead-cat bounce pattern. Here, selling short is the best bet to make profits.
Prices moved lower, allowing the market to adjust and hit an annual low. After the lowest low position is attained, the trader should spot the buy signal. Buying at point D will provide maximum returns to the trader willing to go long.
The two dead-cat bounce patterns are seen to allow a gap up and a one-day increase in price similar to the inverted dead-cat bounce formation. The dead-cat bounce still stands as opposed to the inverted form since prices continue to decrease until it hits recovery.
Figure 2 shows that the price rises by 10.16%. For stocks that rise by more than 10% after identifying the IDCB, then the best time to sell the stock is the following day. In figure 2, the price declines from March 17 until March 22, 2021.
- Sell above gap-up
Upon identification of the gap-up, as the stock’s price ascends, the trader should consider selling the stock in the short term before identifying the recovery point. As noted, the inverted dead-cat bounce pattern does not support the nose dive. It breaks it up and allows the share price to recover.
Figure 3: Selling and buying points in an IDCB
Figure three shows two strong buying points after spotting the inverted dead-cat bounce. The stock soars 16.29% after hitting an annual low, showing that the IDCB had a strong momentum to the upside.
The sell signal was given briefly after the share reached $73.17 on March 17, 2021. This region provided important support for the price to hit a short retracement before peaking again. Selling at this point should only be limited to a maximum of 2%. The two dead-cat bounce locations should guide the trader in choosing the selling locations.
You should not sell longer than the stock has declined during the formation of the dead-cat bounce pattern. The first dead-cat bounce pattern was viewed on February 17, 2021. At this level, prices declined 1.69% from $72.39 on February 17, 2021, to $71.17 on February 22, 2021. The second dead-cat bounce took place on March 5, 2021, when prices were down 1.84% from $71.17 to $69.86.
In figure 3, the decline occurs exactly 30 days of one month after the dead-cat bounce pattern was spotted. Prices fell 0.45%. In this case, the trader should be careful not to exceed the level put by the support when selling the stock.
- Put a stop-loss
A stop-loss is necessary when you intend to execute a quick sell option. Put a stop loss at most $1 below the lowest low position after spotting the inverted dead-cat bounce pattern. The stock’s price may take a nosedive and follow the dead-cat bounce formation rather than making a recovery.
For example, in figure 3, prices fell to $69.86 on March 5, 2021, when the trader noticed recovery. Place the stop-loss at $68 in case the price may decide to go lower after initiating the buy move. The stop-loss is also necessary when making the sell move. Place it at least $1 after the price point.
Traders will notice that prices regain their upward momentum in an inverted dead-cat bounce as opposed to a dead-cat bounce pattern in the short term. Price moves may range from 1% to 30%, depending on the influential status of the news release. Use a stop-loss when initiating buy or sell moves to avoid losses.