Dead Cat Bounce or Bear Trap?
Over the weekend, Western countries such as the US, European Union, Great Britain, and others, ramped up financial pressure on Russia to punish them for invading Ukraine. By expelling some Russian banks from SWIFT or the Society for Worldwide Interbank Financial Telecommunication, a global network that processes financial payments between different countries, the intention is to sever the Russian central bank from the global financial markets. Stocks initially sold off sharply at the opening but staged another strong rally into the close, reversing most of the losses.
Investors hate uncertainties, and the escalation in the conflict between Russia and Ukraine has created one of the worst geopolitical crises in Europe in decades. Risk assets such as equities have tumbled soon after the Russian invasion of Ukraine.
The head and shoulders top patterns, the lower-highs, the lower-lows, and the choppy trading over the past few weeks suggest most traders have become increasingly bearish.
Market and consumer sentiments, including AAII bull/bear, Investors Intelligence, University of Michigan consumer sentiment, and the Conference Board consumer confidence, have moved to extremes. The recent jump in bearish sentiments to extremes may be favorable. If everyone is pessimistic, there are few traders left to sell.
However, the market tape is not easy to read when geopolitical tensions can turn on a dime with each turn of events. The last trading day of the month is today, and this raises the question of whether the recent rally is another dead cat counter-trend bounce in a cyclical bear? It also brings to mind whether the 2/24/22 lower-low pattern is a false breakdown or a bear trap, prompting the resumption of the intermediate-to-longer term uptrend?
A bear trap is a steel apparatus with steel jaws designed to trap black or grizzly bears. A bear trap is also a technical pattern that often occurs when falling security reverses direction and begins to rise again, either through a temporary short-term or intermediate-to-long rally. A bear trap occurs when several technical factors culminate in a condition that leads to a short-squeeze or short-covering rally. Bears shorted positions on a breakdown get caught on the wrong side of the trade as a sudden and explosive rally forces them to cover and buy back their shorts.
A dead-cat bounce is based primarily on the notion that even a dead cat can bounce when it falls from a great height. A dead cat bounce is also a financial market expression that originated in the UK during the volatile markets in the 1980s. The jargon revolves around the concept that even a stock or market that falls far enough and fast enough can bounce. However, the bounce is a temporary rally or recovery followed by the continuation of the downtrend. It is a classic example of a sucker’s rally.
As we can see by the escalation of the Russian/Ukraine crisis, geopolitical events can directly influence financial markets near term. However, the Fed rate hike in two weeks remains the game-changer that can alter the directional trends of the financial markets from an intermediate-term perspective.
Again, how do you know if this is a dead cat bounce or a bear trap?
Price is critically important when deciding if the recent rally is a dead cat bounce. Once the security rebounds to key resistance, often to a previous technical breakdown, the trend quickly reverses down. The reversal back down warns that the rally is likely a dead cat bounce. However, the confirmation occurs when the security records a lower-high and a new lower-low pattern.
Price also plays a pivotal role in determining a bear trap situation. A bearish trader will often short the market or security to profit by buying back the stock when the price has declined to a lower level. If the decline does not occur or the price turns sharply higher it may be a bear trap. The confirmation often occurs when the security or the market trade convincingly above the breakdown, forcing the bears to cover their shorts.
Enclosed are support and resistance levels coinciding with technical levels that can help confirm a dead cat bounce or a bear trap for popular stock market indexes. We recommend traders and investors closely track these pivotal levels in the days and weeks ahead, especially into the all-important Fed FOMC meeting from March 16-17.