Surprises of economic, political or technical nature become frequent in the Forex market
Investors are made of flesh and blood too. They always want what they don’t possess. When EUR/USD is being traded in the narrowest quarterly range ever, the participants of market battles dream of explosive movements. When this or that currency drops down a few figures within a few seconds, they say calm is better than storm. The latter case may be about a dead cat bounce - a pattern which you can and should exploit to your advantage.
When the price’s diving into an abyss, a hard choice comes up: should we buy the asset that’s gone cheaper or should we refrain from catching falling knives? Thomas Bulkowski, the author of the bestselling Encyclopedia of Chart Patterns, thinks that the causes of a sharp fall in an asset’s price (30% as a rule, which is also true for the stock market) within a short period of time (the major part of a “pitch-down” falls on the first day) are some events of fundamental or technical nature. The market recovers faster after the latter. Fundamental factors may result in a 3-6 month recovery. Then, the bears take back control over the financial instrument and often repeat a trick with a quotes collapse, updating the previous lows at the same time.
The events of the latter years show that Forex may be home to dead cat bounces as well. In January 2015, after the Swiss national bank abandoned its EUR/CHF floor of 1.2, the franc soared against the major global currencies. In particular, USD/CHF quotes dropped down 24 figures or nearly 20% within a few days (the main collapse was registered during the first trading session). It turned out to be the second dead cat bounce. The first one occurred in August 2011.
Dead Cat Bounce in the weekly chart of USD/CHF
A similar situation happened to the pound in June 2016 after the Brexit referendum. No one expected that the UK would decide to divorce with the EU, and GBP/USD collapsed 22 figures or nearly 15% down within 3 weeks. After a short correction in October 2016, there was a flash accident which dropped the pound to its lowest values over 30 years.
Dead Cat Bounce in the weekly chart of GBP/USD
Thomas Bulkowski thinks that the pattern forms during 3 stages. At the first stage, there’s a sharp downward movement, fundamental factors being more destructive to the bulls’ fortress than technical ones. At the second stage, there’s a retracement whose duration is linked to the underlying causes of a Dead cat bounce pattern occurrence. For economic or political events, the duration is normally 3-6 months (the franc needed over 3 years while the pound managed in 3 months). Finally, at the third stage the bears start attacking again and update the previous minimums.
Will the sellers be able to repeat a hat-trick with the Japanese yen? USD/JPY dropped down 4 figures within a few minutes after January’s flash accident (technical factor) and the buyers have fully clawed back their losses since then.
Dead Cat Bounce in the daily chart of AUD/JPY
Thomas Bulkowski recommends forgetting about falling knives and buying an asset as soon as the first bottom has formed. However, go easy on long positions. If the bulls fail to assault and consolidate above the diagonal trend line, there will be a signal to sell. A large-scale build-up of short positions, according to the theory, may result in the formation of new lows.
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Price chart of GBPUSD in real time mode
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