What is Dead Cat Bounce? - cryptocorner

 

What Is a Dead Cat Bounce in Investing?

A dead cat bounce occurs when asset values briefly recover from a protracted downturn or bear market, only to continue the downward trend. Often, downtrends are broken by short-lived rallies or moments of recovery, when prices momentarily increase.

Investors and traders keep an eye out for this chart pattern because it might predict the short-term trajectory of an asset. Since passive investors are long-term investors, they might not be bothered by these short-term price swings; therefore, this pattern is more pertinent to traders with short- to medium-term time horizons.

How can a dead cat bounce?

Price movements and various technical indicators must be carefully examined to identify a dead cat bounce

Several characteristics and patterns may indicate that a bounce is likely to be brief, even though there is no infallible technique:

·     Major Fall Provides the Bounce: 

A dead cat bounce frequently occurs after an asset's price has declined sharply and for an extended period. The likelihood of a brief rebound for traders increases with the visibility of the previous downtrend.

·   Resistance Levels:

During the bounce, keep an eye out for possible resistance levels the price might hit. It may indicate that there isn't any real buying interest if the price finds it difficult to rise above these levels.

·     Absence of Essential Catalyzers:

Examine whether there are any underlying causes for the bounce. If there is no substantial good news or a shift in the overall picture, the rebound is probably going to be brief.

·      Chart Patterns: 

Following the bounce, look for traditional chart patterns such as a descending triangle ora bear flag that may suggest that the downtrend will continue

Reversal Patterns:

Reversal patterns may indicate a potential shift in trend and the loss of control by either the bulls or the bears.

After a lull in the present trend, the price will shift from one side of the market to the other (bull or bear).

At market peaks, a distribution pattern is a reversal in which the traded item is more eagerly sold than purchased. read here for more 

The converse is true for an accumulation pattern, which is a reversal that happens during market bottoms and involves more purchases than sales of the instrument. 

The most typical patterns of reversal are

·   Rising Wedge

·       Falling Wedge

·       Head and shoulders pattern

·       Double-top pattern

·       Double bottom pattern

·       Triple top pattern

·       Triple bottom pattern

·        Inverse Head and shoulder pattern

Bolinger Bond Strategy

One well-liked technical analysis method for spotting possible trading opportunities in the financial markets is the Bollinger Bands concept. Three lines are drawn on a price chart to create the Bollinger Bands, which were created by John Bollinger in the 1980s:

Middle Band: The price's simple moving average (SMA), usually computed over 20 periods.
Upper Band: The SMA plus two price standard deviations are shown above the middle band.
Lower Band: The SMA less two price standard deviations is plotted underneath the middle band.

The volatility of the market determines how the upper and lower bands change dynamically. The bands broaden when volatility is high and shrink when volatility is low.

1. Identifying Overbought and Oversold Conditions:

• When the price touches or exceeds the upper band, the asset may be overbought, indicating a potential selling opportunity.
• When the price touches or falls below the lower band, the asset may be oversold, indicating a potential buying opportunity.

2. Mean Reversion:

• Prices tend to revert to the mean (the middle band) over time. Traders often look for opportunities to trade when prices are at or near the bands, expecting a reversal toward the middle band.

3. Breakout Strategy:

• If the price breaks through the upper or lower band with strong momentum, it may indicate the beginning of a new trend. Traders use this as a signal to follow the breakout direction.

4. Squeeze Strategy:

• When the bands narrow significantly (a phenomenon called a "squeeze"), it indicates low volatility. This often precedes a sharp price movement. Traders prepare for a breakout in either direction during a squeeze.

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Key Tips:

• Combine with Other Indicators: Bollinger Bands are most effective when combined with other technical indicators, such as RSI or MACD, to confirm signals.
• Adjust Parameters: The default settings (20 periods, 2 standard deviations) may need adjustments based on the asset or timeframe.
• Avoid Over-Reliance: Bands are reactive, not predictive. They reflect past price data and may not always accurately predict future movements.

Advanced Price Action Strategies 

These are trading techniques that involve analyzing price movement, patterns, and levels without relying heavily on technical indicators. These strategies emphasize understanding market behavior and the psychology of participants, focusing on the "naked" chart. Below are some common advanced price action strategies:

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1. Support and Resistance Levels:

• Identify key horizontal levels where the price tends to reverse or consolidate.
• Support: A level where buying pressure exceeds selling pressure, preventing further decline.
• Resistance: A level where selling pressure exceeds buying pressure, preventing further ascent.
• Trading Strategy: Look for price reactions (bounces or breakouts) at these levels and trade accordingly.

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2. Price Action Patterns:

• Recognize recurring candlestick or chart patterns that indicate market sentiment.
• Pin Bar: A single candlestick with a long wick and small body, signaling a potential reversal.
• Engulfing Pattern: A larger candle fully engulfs the previous candle, indicating a strong reversal.
• Inside Bar: A smaller candle within the range of the previous candle, often signaling consolidation or indecision.

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3. Trendlines and Channels:

• Use diagonal lines to identify trends (upward, downward, or sideways).
• Combine trendlines with parallel lines to create channels, showing the price's expected range.
• Trading Strategy: Enter trades near the trendline or channel boundaries and exit at the opposite side.

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4. Breakout and Retest:

• A breakout occurs when the price moves beyond a significant level (support, resistance, or trendline).
• Retest Strategy: Wait for the price to return to the broken level to confirm the breakout's validity before entering the trade.

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5. Order Blocks and Supply/Demand Zones:

• Order Blocks: Areas on the chart where large institutional orders caused significant price moves.
• Supply Zones: Levels where selling pressure dominates, often causing price reversals.
• Demand Zones: Levels where buying pressure dominates, leading to price increases.
• Trading Strategy: Identify these zones and trade reversals or breakouts based on price interaction.

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6. Fibonacci Retracement and Extensions:

• Use Fibonacci levels to identify potential retracement or extension levels in trending markets.
• Common Levels: 38.2%, 50%, 61.8% for retracements; 161.8%, 261.8% for extensions.
• Trading Strategy: Combine Fibonacci levels with other tools like support and resistance or trendlines.

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7. Volume Analysis:

• Analyze trading volume to confirm price moves. Strong volume during a breakout or reversal indicates higher reliability.
• Trading Strategy: Trade with the trend when high volume supports the price move; be cautious with low-volume moves.

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8. Multiple Time Frame Analysis:

• Use higher time frames (e.g., daily or weekly charts) to identify the overall trend and major levels.
• Use lower time frames (e.g., hourly or 15-minute charts) to pinpoint entry and exit points.
• Trading Strategy: Align trades with the higher time frame trend while fine-tuning entries on lower time frames. Read here

MACD (Moving Average Convergence Divergence) is a popular technical indicator used in financial markets to identify trends, momentum, and potential reversals in an asset's price. Developed by Gerald Appel in the late 1970s, it is both a trend-following and momentum indicator, commonly used by traders to generate buy and sell signals.

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Components of MACD:

1.      MACD Line:

• Calculated as the difference between two Exponential Moving Averages (EMAs), typically the 12-period EMA and the 26-period EMA.
• Formula: $$\text{MACD Line} = \text{EMA}_{12} - \text{EMA}_{26}$$MACD Line=EMA12​−EMA26​
• This line shows the momentum and direction of the trend.

2.      Signal Line:

• A 9-period EMA of the MACD Line.
• Plotted alongside the MACD Line to provide buy or sell signals.

3.      Histogram:

• Represents the difference between the MACD Line and the Signal Line.
• A positive histogram indicates bullish momentum, while a negative histogram indicates bearish momentum.

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How to Interpret MACD:

1.      Crossovers:

• Bullish Crossover: When the MACD Line crosses above the Signal Line, it may indicate a buying opportunity.
• Bearish Crossover: When the MACD Line crosses below the Signal Line, it may signal a selling opportunity.

2.      Divergence:

• Bullish Divergence: When the price makes a lower low, but the MACD makes a higher low, it suggests weakening bearish momentum and a potential reversal to the upside.
• Bearish Divergence: When the price makes a higher high, but the MACD makes a lower high, it indicates weakening bullish momentum and a potential reversal to the downside.

3.      Histogram Movement:

• Increasing histogram bars suggest strengthening momentum in the direction of the trend.
• Decreasing bars suggest weakening momentum.

4.      Centerline Crossovers:

• When the MACD Line crosses above the zero line, it signals that the 12-period EMA is above the 26-period EMA, indicating bullish momentum.
• When the MACD Line crosses below the zero line, it signals bearish momentum.

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Example of MACD in Action:

1.      Buy Signal:

• MACD Line crosses above the Signal Line.
• Histogram moves from negative to positive territory.
• Confirmation: Price is trending above key support levels.

2.      Sell Signal:

• MACD Line crosses below the Signal Line.
• Histogram moves from positive to negative territory.
• Confirmation: Price is trending below key resistance levels.

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Strengths of MACD:

• Simple to use and interpret.
• Combines trend-following and momentum analysis.
• Effective in trending markets.

Limitations:

• Can generate false signals in choppy or sideways markets.
• Lags behind the price, as it is based on moving averages.
• Requires confirmation from other indicators or analysis methods for reliability.

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Practical Usage Tips:

• Combine MACD with other indicators like RSI, Bollinger Bands, or volume analysis for better accuracy.
• Use MACD divergences to identify potential trend reversals.
• Adjust the default settings (12, 26, 9) for specific assets or trading styles, such as short-term or long-term trading.

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References:

Books:

1.      "Technical Analysis of the Financial Markets" by John J. Murphy
Covers MACD and its use in conjunction with other indicators.

2.      "Trade Your Way to Financial Freedom" by Van K. Tharp
Discusses integrating MACD into broader trading systems.

3.      "High Probability Trading" by Marcel Link
Provides insights on using MACD in practical trading scenarios.

Articles:

1. Investopedia - MACD Explained
   An in-depth guide to understanding and using MACD.
2. BabyPips - MACD for Beginners
   A beginner-friendly explanation with examples.
3. TradingView - Shared strategies and charts incorporating MACD