Was Tuesday’s Rebound a Dead Cat Bounce?

After stocks had their worst day since the 2008 financial crisis, they rallied back hard Tuesday. In fact, the Dow's 1,100-point gain was its third largest daily point gain ever, behind only two days last week.

If you think the market is volatile, you're right.

The question investors have now is whether that was the end of the correction or just a "dead cat bounce."

Before we answer that, let's first talk about what a dead cat bounce is. This is a short-lived rebound in the market after a lot of losses, so named because supposedly even a dead cat will bounce when dropped from a high enough place.

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In other words, it's a false hope before markets fall even more. There will always be short-term scalpers around to buy beaten-down stocks and sell out after only a quick rebound.

And some of the largest dead cat bounces occur in the midst of a bear market.

To find out whether stocks are ready to rally again or Tuesday's gain was just a short-lived rebound, we're looking at three indicators...

3 Signs the Stock Market Will Reignite

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First, see if stocks can maintain a level of support.

Many traders and just about all the financial media say that a 10% drop in price is a correction and a 20% drop is a bear market. The problem is that these things only trigger after the drop has occurred. Still, they do give us an idea of where we stand.

At its worst levels this week, the Dow was down 19.8% from its all-time closing high. Does it matter whether it was 19.8% or 20% - not one bit. But it was a sharp and fast move that left investors reeling.

Further, the lows came very close to the lows we saw in early 2018, after the market was finally knocked off its low-volatility, steady bullish trend. Chartists call this a level of support, which really just means that's where buyers got busy once again. They saw it as a value area.

This is not a guarantee that it marks the bottom now, but it is a likely suspect.

Second, look for buying volume to outpace selling.

It's no secret that NYSE volume has been huge over the past two weeks. That means a lot of people are taking action and putting their money where their mouths are. For much of the decline, down volume was far and away the winner over up volume. That means selling dwarfed buying.

What we want to see is the opposite. A few days where buyers were much stronger than sellers would be a sign that investors are back and want to buy again.

Third, look for market breadth to favor advancing stocks.

When fewer stocks are falling than rising each day, and fewer stocks are making new lows, it tells us that even though the major indexes are still looking weak, there are plenty of stocks beneath the surface that are improving. We see this at important market tops that only a few stocks are driving major stock indexes to new highs. The same is true at bottoms.

This is called the advance/decline line, and all it does is take the number of stocks going up each day minus those going down. We want that balance to start favoring advancers again.

When the Dow was smacked for over 2,000 points to the downside Monday, more than half of all issues traded on the NYSE hit 52-week lows. That is a lot of stocks in private bear markets.

What we want to see here are fewer and fewer new lows each day. Rising numbers of new highs will be a tough call since the entire market has fallen so far. But fewer lows means buyers are starting to scoop up these beaten-down shares.

No doubt, Tuesday's rally made a lot of progress in all these areas. But is one day enough? Probably not. If we see a few more good days, then we probably can put the idea of a dead cat bounce on the shelf and be happy that the dark days are over.

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