HOW THE DEAD CAT BOUNCE STOCK TRADING PATTERN WORKS by Michael Swanson Hello my name is Michael Swanson and I m the author of Strategic Stock Trading and The Two Fold Formula, which is a book about the single best buying pattern that I have ever used while investing in an ETF or an individual stock. However, I have been in the markets now going on my third decade and over the years I also have made nice money at times betting against the stock market and individual stocks. This year I once again began to devote a portion of my capital to betting against individual stocks, because the stock market has simply become more volatile in what I believe is a giant topping pattern so far this year. Most people out there don t agree with that and that s fine if you don t, because the fact of the matter is that the stock market leadership is simply getting more narrow and many stocks are beginning to act weaker than the stock market averages and are declining anyway. Now I have long positions in all of my accounts and I am really using my short positions the way the first hedge funds did by having both long and short positions. Having short positions can act as a hedge in a portfolio to help lower overall portfolio volatility and risk. They also can be used as pure profit trades, because the reality is that stocks go down a lot faster than they go up. The top performing stocks in the market tend to double or more over the course of a year. Think about NVDA in 2017 or 2016. The worst stocks though can dump and crash in mere weeks to lead to quick gains and even 100% to 1000% pyramid gains in put options positions. The thing is though most people make a big mistake in their trading no matter whether they are buying to go long or betting against a stock and that is they don t get in at a good entry point. Way too often someone just buys AFTER they have seen something make a big move up and end up chasing price action just as insiders are unloading and the move is ending. And if they are betting against a stock they do so AFTER a stock crash and then get squeezed on a rebound. The wonderful thing about stock trading though is that YOU can CHOOSE how you enter a position. There is no need to chase when there are virtually unlimited opportunities and setups every single day. All you have to do is pick your setup and let it materialize. My book The Two Fold Formula shows how to do this for going long stocks and ETF s, because it simply lays out the single best buying that pattern that I have ever used.
When looking for stocks to bet against I basically turn this buying pattern completely upside down to find the optimal time to short a stock or buy a put option on it. I call this my Dead Cat Bounce Stock Trading Setup. This pattern involves using a rally on a broken stock for an entry point. By waiting only for this pattern to materialize you avoid betting against a stock at the wrong time after it drops and do so only when the maximum risk to reward entry point is at hand. It s a very simple technical price pattern that aligns a bearish long-term trend in a stock with a short-term bounce for an entry point. And now there are lots of stocks lining up like this every month. So let me show you how this pattern works. First for the long-term trend I use what I call stage analysis to define whether a stock is in a bull market or a bear market. Stage analysis simply looks at how the stock is doing in relationship to its 150 and 200-day moving averages. In a stage two bull market the long-term 150 and 200-day moving averages trend up and act as solid price support. In a stage three top price goes sideways in a volatile up and down manner while the moving averages begin to flatten out. To show you an example one of the worst performing stocks of the past few years has been Chipotle.
Chipotle went through a giant stage three top in 2015 and has been one of the worst performing stocks in the entire stock market ever since then even though it recently had a rally. More recently Tesla is a stock that has just completed a stage three topping process in the past few months. I am actually short Tesla shares as I write this report. We ll examine Tesla more closely in a moment. First I want to point out to you that during a stage four decline that follows this topping process both the 150 and 200-day moving averages slope down and act as price resistance. You can see what I mean with this chart of GE above. Stocks fall faster than they go up. It took years for GE to go to over $30 and only one year for it to fall from $30 to below $14. The story for CMG is the same too. It took years for it to get to over $700 and only months to fall
50%. I expect Tesla will also dump over 50% before this year is over too and maybe even fall more than that. Those are fast gains and if you use options can lead to pyramid gains on a trade. But the Dead Cat Bounce Trading Pattern provides an entry point for these situations just as The Two Fold Formula provides the best timing model for going long. The best time to go long is when a stock is in the process of completing a stage one basing phase and is beginning a new stage two bull market. To find the best time to bet against a stock we simply flip the pattern upside down. The Dead Cat Bounce Trading Pattern comes after a stock completes a stage three top and dumps and then has a failed rally back up into its 150 and 200-day moving average. If shorting shares we can then place a stop loss level at the stocks 52-week high in order to clearly define the risks on the trade. Let s look at GE again. The Dead Cat Bounce entry point came in GE where I have placed the blue arrow. GE had gone sideways for almost two years and then in the summer of 2017 it fell to a new 52- week low diving away from its 150 and 200-day moving averages. It then bounced back up to those moving averages in a failed rally to provide a Dead Cat Bounce entry point. You could have shorted GE shares and then placed a stop above those moving averages or its 52-week high for a clearly defined risk entry point or just bought put options on GE to profit when it dropped. Now maybe you would have been hesitant to bet against GE at the time as it didn t crash before bouncing. That s ok, because there are countless stocks to watch for the perfect entry point. You can find stocks that really dump after completing their stage three top and then bounce back to the moving averages to provide for a Dead Cat Bounce Entry point.
Most people just focus on one or two stocks or only try to trade the popular stocks talked about on TV. That leads to impatient trading and chasing moves after they happen, but if you do the work you can watch thousands of stocks and then simply use only the most optimal of setups. That s the wonderful thing about stock trading when done in a serious manner. The fact is right now every month new stocks are lining up like this thanks to the stock market volatility and narrowing internal leadership. Tesla for example just completed this pattern. Tesla traded all of 2107 with price support at the $300 level and by October its 150 and 200-day moving averages began to flatten out. This March it broke $300 and simply dumped falling over 40% from its 52-week high. After that hard drop hit the stock though in April it bounced back up above $300 and went sideways for several weeks even getting close to its 150 and 200-day moving average. That bounce represented a Dead Cat Bounce Stock Trading entry point! I am short Tesla stock and pointed out this entry point to people in my private Power Investor group and inside a secret Facebook short selling group that I manage. I still think the stock can be shorted now, but anyone could have used that entry point and placed a stop loss on a TSLA short position above the 200-day moving average. I expect that TSLA is going to do what GE did going forward to lead to juicy gains for those of us betting against it. Now I m not telling you to bet against TSLA now. You don t have to do that, because there are more and more stocks lining up like this with the way the stock market is going up and down now.
There is one problem you ll run into though if you only use this pattern to find stocks to bet against. This pattern is great for an entry point, but it doesn t really tell you what the downside potential is in a stock drop and you really need to know that too in order to decide which stocks are worth betting against and which are not. The best stocks to bet are junk POS stocks. Tesla is a company with a lot of problems. That s why it was a perfect stock for a Dead Cat Bounce entry point. The thing is you can t really use this pattern in just any stock or you won t get the gains you want. It doesn t make sense to bet against a stock if the stock has a cheap fundamental valuation and its earnings are going to grow! So I use this Dead Stock Bounce Trading Setup as an entry point in only junk stocks. For my starting point I look for junk stocks to use the pattern with! I call them POS stocks. If you want to find out what a POS stock is I have created an entire series of videos about them and how to find them. Just use this link below or type this domain in your internet browser: http://www.targetposstocks.com PS: Once you go to www.targetposstocks.com you ll find the info on how to get into my private POS Facebook group. -Mike Swanson