The Anatomy of a Short-Term Bounce

Short-term bounces aren’t meant to go straight up.

There is plenty of reason to expect a stock market bounce right now, but it doesn’t mean that stocks go straight up with out any resistance or push back. Once there is a meaningful reversal day, whether it is a major rally on strong volume, or a critical bounce off of a technical level, I always expect that there will be plenty of uncertainty in the early going about whether the bounce that is believed to be underway, will actually hold.

No doubt, there will be times when a short term bounce rockets straight back up to all-time highs or new rally highs, and it’s great when that is the case. But it isn’t the norm, nor should it be. Especially when short term bounces revolve around dead cat bounces. For those not familiar with the term, it is exactly as it sounds: a dead cat bounce is when a stock’s price or market index falls a lot, then goes up a little bit for a short time, but then it keeps falling again. Yes, just like if you threw a dead cat off a building, it might bounce up a bit before falling back down.

What kind of short-term bounce is this?

The nature of a dead cat bounce, by definition, not being sustainable should lead you to believe that the bounce will be anything but clean. Currently that is what I think this market is in – a short-term bounce that is nothing more than a dead cat bounce that will eventually fizzle out and break the lows of the previous week at some point. I am attempting to play that bounce to the long side, but I’m certainly not married to it, unless the market shows me other wise.

Look at some of the other recent bounces, plenty of them struggled in the first 2-3 days, often back test or posting some steep intraday sell-offs before righting the ship for a decent trading opportunity to the long side. And that is pretty much exactly what we have going on here right now.

Short-term bounces aren’t clean

And even now, just a couple of days into this current bounce, we’re seeing plenty of hesitation and push-pull in the price action, which is exactly what you’d expect for a market that’s trying to find its footing on shaky ground. Remember, short-term bounces can be extremely volatile: they’ll often look great one day and then completely disappoint you the next. That’s just how the market likes to operate following a pullback. It wants you to doubt the legitimacy of the bounce.

Whenever I’m trading these bounces, I place extra emphasis on managing my position sizes. Where I can take partial profits – I do exactly that. I was up +4% on my UPRO trade today, it took 1/3 off the table, which is similar to raising the stop on the trade, because of the fact that I’m reducing the risk on the overall trade. But in this case, I’m doing it by reducing my position size.  While I think this dead cat bounce will ultimately fail, I’m not married to the idea that it must fail. But if it does start to show signs of real strength backed up by volume and improved breadth, then I’m willing to adjust, and increase the number of positions in the portfolio. That’s the key: you can have a hypothesis that a bounce is only temporary (as I do), but you should also stay open-minded if the market surprises you with genuine buying conviction.

With that in mind, it helps to zoom out occasionally and remind yourself of what larger support and resistance levels look like on the daily and weekly charts. Sometimes you might notice that the bounce lines up with a prior area of support, or that a key moving average is helping to provide a floor for prices. Other times, you’ll see that there’s a wall of overhead supply just waiting to thwart any attempt to rally. In either scenario, it pays to have a technical roadmap in place, so you don’t get caught off guard.

You need flexibility

All in all, the name of the game for short-term bounces is flexibility. I often treat these setups like a “prove me otherwise” scenario, meaning I take a trade on the long side if there’s a decent risk-reward and clear support to lean on, but I’m not betting the farm on it. And if the bounce starts to fizzle, I’m quick to reduce or close the position altogether. A nimble mindset can be your best weapon.

At this point, the market is still in the very early stages of what might be a dead cat bounce. Sure, there’s a chance it could morph into something more lasting, but for now, though, I’m sticking with the idea that it’s nothing more than a short-lived pop until proven otherwise.

Bottom line: always keep one foot out the door until price action convinces you it’s time to stay for the party. That’s the anatomy of short-term bounces—messy, choppy, and uncertain, but also potentially lucrative for those who maintain the discipline and flexibility needed to trade them well.