Catching the Dead Cat Bounce

dead cat bounce is when a stock or the market falls a long way, then becomes so oversold and cheap that value investors rush in and bid the price up a little.  The term comes from the observation by one trader that “if it falls far enough, even a dead cat will bounce!”  Trying to catch a dead cat bounce, however, is very tricky and not a good strategy for making your fortune.  Instead it should only be done under very special circumstances.  These are:

1) The stock is one of your long-term buys that you are planning to hold for years and years.

2) You are investing with money you can afford to lose.

3) You aren’t just averaging down to avoid dealing with a bad stock selection.

4) You are ready to see the price of the stock continue to fall as you mis-time the bounce and watch the stock fall further.

Unfortunately, I had the opportunity to take advantage of a dead cat bounce the other week in Oasis Petroleum (OAS). Please refer to the chart of the stock here as a reference.  Now the reason I say, “unfortunately,” is that I had originally bought the stock in the $45 range last September.  I had bought into Oasis Petroleum to broaden the types of industries I’m invested in, which had been concentrated in consumer discretionary (restaurants and retail stores).  Oasis is an oil producer, mainly focused on the northern US oil boom.  I liked Oasis because they have strong 3-5 year projected returns in Value Line and because they were in the energy sector – a sector to which I had little exposure.  In hindsight (and maybe a bit of foresight), I should have waited because I was buying into an area that had already had a big run-up in prices and was due for a correction.

Well, anyone delighting at two dollar gasoline knows what happened next, even if he doesn’t follow the stock market.  Oil prices collapsed, which caused the price of Oasis Petroleum to fall with the rest of the oil-producing sector of the market.  I sat and watched as the stock sank into the $30’s, then looked like it would hold in the high $20’s, then completely collapse into the low teens, finally bottoming out at $11 per share.  As it turned out, I timed the dead cat bounce almost perfectly, buying in again at $12 per share and then seeing the stock rally over the next few days.  It is currently trading around $17 per share, giving me a 42% profit on the new shares I bought, although I am still obviously losing money on the entire position since I have lost about $28 per share on the shares I had originally bought.  The nice thing, however, is that I only need to see shares increase to $30 per share to break even instead of going all the way up to $45 again.  That’s the advantage of averaging down when it is done for the right reasons.

So how do I have the right reasons for averaging down in this case?  The first reason is that I see Oasis Petroleum as a long-term buy that I plan to hold regardless of price movements as they develop and grow.  The second reason is that the entire oil-producing industry is falling through the floor, taking both good and bad stocks down with it.  It is nothing fundamental about Oasis Petroleum that caused the decline – it is the whole market.  It is times like this when an industry is in a free fall that really great buying opportunities emerge.  I just picked a really bad point to enter the first time.

The first danger of trying to catch a dead cat bounce is that the stock will often fall further than you thought it would.  I had looked at getting into Oasis Petroleum again when it had dropped into the mid-twenties since it appeared to have settled out there.  Then came a one-day drop to the $15 range, and on down to $11 per share.  If I had a trader’s mentality, I probably would have sold out when the price dropped to $11 – which would have been exactly at the wrong time.  Because I have an investor’s mentality, I know that I cannot time the market and cannot get the ideal price most of the time.  I just accept the fact that $12 per share is a lot better than $45 per share, even if the stock eventually goes to $6 per share before it finishes its slide.  This is why you need to buy stocks you’re interested in for the long-term, since that allows the stock the time to recover and grow.

The second danger is that there could be something fundamentally wrong with a stock that falls through the floor.  Some stocks never recover.  In this case, because the entire industry was falling and it doesn’t appear that there is anything about Oasis Petroleum’s management or prospects that is causing the issues, that is unlikely.  Still, this is why you don’t invest more than you would be willing to lose, no matter how good a deal it appears to be.  You also don’t keep averaging down, because at some point you’re in it for pride rather than profit.  Every investor takes a loss at times.  It is the best investors who know when to give up, dust themselves off, sell a losing position, and look elsewhere.  Poor investors sit on losses because they are unwilling to admit they were wrong.  They then end up with portfolios full of losers.

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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

8 thoughts on “Catching the Dead Cat Bounce

  1. Here is my 2 cents worth. I think that you should have put in a stop loss on your oil stock to play it safe. Taking a 10% to 15% loss on initial investment and then catching a dead cat bounce could have ended up as a profitable trade.

    • Thanks for the comment and thanks for reading The Small Investor. You are absolutely right that stop loss orders are good ways to limit your losses with the exception of rare events like the Flash Crash that occurred a few years ago, where prices cratered for a few minutes due to an imbalance between buyers and sellers and the effects of automated trading programs. Such events could cause you to take a big loss if you have a stop loss order in place, only to have prices immediately rebound.

      I’ve left the world of trading, however, and gone into what I call Serious Investing. I invest in companies that I think have good long term prospects and then plan to hold them through think-and-thin market cycles, only selling to cut a position down to reasonable levels or because the prospects for the company have changed. Stop loss orders are not part of this strategy since that would cause me to sell out of stocks for no reason other than the fact that the price declined. I have many positions in my portfolio that fell by 10% or more in the past that are now 100%+ gains. If I had used stop loss orders, I might have never bought back into those companies. I also am willing to take some 50% or even 100% losses because I know that a few 1000% gains will cover them and then some.

  2. Sorry, but If I really believe in a stock, I would rather take a small 15% loss and buy it back if it continues to fall. I am not a trader, but a stock that falls 50% usually takes two to three years to recover. In the meantime, I can buy something else that may turn into a 100% gain. Yes, sometimes a market short term correction can stop me out but I didn’t lose 60% on my portfolio during 2008-2009 crash. It took three years for the buy & hold guys to just to break even.

      • I have never see a blue chip stock fall 15% and bounce back. I have seen some tech start ups bounce like that but I am an investor not a trader. Sometimes I put some play money in a margin account and trade options.

      • I’ll agree that it is rare to see a correction of 15% in a bull rally, but it does happen. Bristol-Myer Squibb (BMY) fell almost 20% between March and June of this year, then continued its rally.

        If you had sold out and then waited for the next entry point, you might have missed the huge jump in late October.

        I would rather buy more while the shares are on sale if I am planning to stay invested in the company rather than sell at a loss and then try to time a bottom. If I were buying into a local pizza restaurant, I wouldn’t sell just because the price of businesses in the area dropped during a given week or month. I just care about the business and would stay invested, waiting for the rise in value that will eventually come. I don’t know when it will be and I don’t want to miss it.

        Note I also take the chance of having a wash sale if I sell out and then buy back too soon, which could eliminate my tax deduction for the loss.

      • The stop loss amount is not fixed in stone. I do make adjustments. I also use charts and moving averages to determine new selling points. The stock market is up for 70 straight months, the longest since World War II, I am too old to lose 50% of my wealth. I am raising some cash.

      • Absolutely, the risk you take is based on when you need the money. I’m talking about long-term investments (20+ years), trying to catch the next Microsoft. That isn’t something you should be doing with a significant amount of your money if you need the money in five or ten years. As you know, the amount of money you put into growth depends on 1)your stage in life and 2)how much money you have more than the amount you really need. If I were close to retirement, I would have a stockpile of cash, some income assets (under more normal interest rate environments than we’re in now), and mainly index mutual funds or index ETFs for stock holdings. I would just have the extra money where I could afford to see a 50% drop in single stocks, but there I would be looking for either strong growth or maybe reliable income.

        Thanks for the comments and please keep reading and providing your input.

Comments appreciated! What are your thoughts? Questions?

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