Top Tips for Identifying THIS Pattern
Patterns in data are something every successful investor should be paying close attention to when trading.
Knowing how to analyze trends will help you better understand the market and make the BEST decisions when trading.
In yesterday’s issue, we covered some of the basics of the dead cat bounce pattern. Especially, how to recognize it when analyzing downward trends in your portfolio.
So you think you’re ready to identify those patterns and capitalize on them?
Here are some key tips for using the dead cat bounce to help you approach your trades responsibly.
Always Use a Stop Loss
Things can happen fast when a dead cat bounces.
Once you’ve found a dead cat bounce and decide to sell short, it’s important to short when the price action is breaking and goes below the last bottom.
By timing it outright, you can maximize the potential for taking advantage of the continuing price decrease.
The thing is, this can happen very, very quickly. And adding to the stress of the situation, you can’t always be sure that it’s just a bounce. Sometimes, what you think is a dead cat bounce could be a longer-term trend reversal. If you’re a short seller, that is not desirable!
To stay as safe as possible, it’s a good idea to place a stop loss order.
A stop loss order is a way to help limit your losses, and as you know, I consider minimizing losses to be one of the most important things you can do as a trader.
With a stop loss, you determine the maximum losses you’re willing to sustain and set an order. If the price goes below the stop level you establish, your position will be closed, meaning that you can avoid further losses.
Because things can change and quickly, a stop loss order can help you mitigate risk and help you cut losses quickly if needed.
How to set the stop loss? Well, that will ultimately depend on the volatility and the price of the stock in question. For example, a low priced stock might require a fairly small stop loss, but if the stock price is $100 per share, things are a bit different.
For a reference point, many traders will choose to set the stop loss just a little higher than the top of the pullback (the short term price drop) to help reduce risk. Why? Because if the trend does continue to move upward, as a short seller you could really lose big.
Never Trade Too Big
In case I haven’t stressed it enough, dead cat bounces can be risky. Any type of trading can be risky, of course, but because of the fast pace and uncertainty involved in dead cat bounces, they present a particularly high level of risk.
Yes, it’s a pattern, but that doesn’t mean it’s going to play out exactly as you’d expect every single time. There can always be deviations.
As such, you should never trade too big.
With dead cat bounces, it’s important to create a strong trading plan detailing your entry and exit points. A trading plan is super important for every trade, but it’s especially important when trying to take advantage of the dead cat bounce because of the high level of risk and the many unknowns.
When you make a trading plan, you’re forced to do research to make a case for your trade. Not only does this assist you with plotting out how reliable the pattern in question is, but it can help you stay accountable and responsible in the trade.
By looking at the past performance of the stock and considering technical indicators, you can better determine how it might react in the future for the next bounce.
However, even the best-laid plans won’t always work out as you’d like. The market is subject to a myriad of factors like shifts in the economy, catalysts within the sector, et cetera. You can’t count on anything as a sure thing in trading.
That is to say: anything that you put into a trade could potentially be lost. So you don’t want to put more on the line than you’d be able to lose.
So what does trading “too big” mean? This will differ for every trader based on their account size. But ultimately, don’t bet more than you can’t comfortably lose.
There’s a big temptation for traders, especially those with small accounts, to go “all in” with trades. After all, if you want to grow your account fast, you’ve got to go big or go home, right?
Wrong, wrong, wrong. This type of thinking is really more for movie montages than actual life, and in real life you could drain your account in practically the blink of an eye.
Instead of going for an ace in the hole, focus on slow but steady growth. Taking smaller positions is fine, and if your profits are relatively small, that’s ok. Even if your profits after fees are $10 or $15, it’s still $10 or $15 more than you started with.
They will build over time, and so will your experience, so as your account grows so will your knowledge level, and you can begin taking bigger positions.
Improve Your Stock Market Knowledge
Work hard, every single day, to improve your stock market knowledge.
This might seem like an indirect way to improve your dead cat bounce prowess, but trust me, it has everything to do with increasing your odds of finding success with this pattern.
For instance, right now, you’ve taken the time to read these issues about dead cat bounces. Just by doing that, you have probably already begun to understand what a dead cat bounce is and how to approach it.
From this point, you have a better sense of direction for how to locate dead cat bounces, and what types of strategies you might pursue.
On the flip side, maybe you’ve been reading about dead cat bounces and you think “Nope, that’s not for me.” Believe it or not, even if you have no interest in dead cat bounces, it wasn’t a waste of time to learn about them.
Learning about trading techniques you don’t want to pursue can be helpful too. Why? In choosing not to pursue certain styles of trading, you learn a lot about your personal style as a trader, and you give yourself more space and time to continue working on and refining the techniques you do prefer.
So even if you never intend on trading a dead cat bounce, learning about the pattern can help your trading career.
Overall, the more you learn about the stock market, including common patterns, market mechanics, and how to look at stock charts, the more nimble and knowledgeable you will be.
This means that when it comes time to craft a trading plan, plot entry and exit points or identify trends, you’ll have a bigger wealth of knowledge to draw from.
You’ll literally never know everything there is to know about trading, but that shouldn’t stop you from learning all that you can. More than anything else, this will help you stay adaptable and allow you to evolve along with the market.
I’ve been trading for decades, and I’ve seen cycles come and go. Continuing to learn is one of the biggest ways I’ve been able to stay relevant.
The Bottom Line
When you understand and have the ability to anticipate patterns like the dead cat bounce pattern, you can potentially take advantage of downward trends in the market. Talk about a silver lining!
Of course, it’s important to remember that dead count bounces aren’t infallible. It can be hard to know whether it’s a dead cat bounce or a trend reversal.
Understanding all that you can about the market and learning how to evaluate this pattern will help you better determine if this is a style of trading you want to pursue.
— Tim Sykes
Editor, Penny Stock Millionaires