A sucker rally describes a price increase that quickly reverses course to the downside. Sucker rallies often occur during a bear market, where rallies are short-lived. Sucker rallies occur in all markets, and can also be unsupported (based on hype, not substance) rallies that are quickly reversed.
A sucker rally of at least 5% (higher) can occurred in all bear markets, and frequently more than one occurs over the course of a bear market.
Sucker rallies are hard to identify in real time. Therefore, some traders opt to wait for a series of higher swing lows and higher swing highs before buying.
Sucker rally is a slang term referring to the temporary rise in an asset, like a stock, or the market as a whole, which continues just long enough to attract investment by naive or unsuspecting buyers. The buyers are the suckers since they are likely to lose money on the trade when the price heads lower again. This phenomenon is also known as a dead cat bounce, a bull trap, or a bear market rally.
Sucker rallies frequently occur when the price of a stock noticeably rises despite that the fundamental aspects of the stock have not changed. In most cases, these fundamentally unsupported price increases result in a large drop, usually continuing an overall downward trend. Sucker rallies frequently occur amidst bear markets, where small price increases attract a few buyers but then the selling continues in large quantity.
Sucker rallies are easy to identify in hindsight, yet in the moment they are harder to see. As prices fall, more and more investors assume that the next rally will mean the end of the downtrend. Eventually, the downtrend will end (in most cases), but identifying which rally turns into an uptrend, and not a sucker rally, is not always easy.
Identifying a sucker rally can be challenging, even for experienced traders. Sucker rallies appear and disappear without warning, especially during a period of downward-trending market action, such as a bear market.
A bear market is typically indicated by a 20% drop in the stock market, and tends to occur when the market is overvalued. During a bear market, investor confidence tends to be low, and traders watch eagerly for signs of upward movement in the market. Inexperienced or panicking investors may be tempted by market upticks, making these investors especially vulnerable to the whims of a sucker rally. They want to buy because they don’t want to miss out on any upside that may develop. They are essentially bottom fishing.
Rallies are common occurrences during bear markets. Notably, the Dow Jones Index experienced a three-month rally following the Stock Market Crash of 1929, although the overall bear market continued on a greater decline until bottoming out in 1932.
Bear markets frequently spawn at least one rally of 5% or more, but then proceed lower, before the market begins an uptrend. That means that bear markets can have at least one, and usually more, sucker rallies.
Because bear markets may last for long periods of time, they can exact an emotional drain on investors hoping for a market turnaround. Market advisors warn against emotional responses to market volatility, as investors may panic and make judgment errors regarding their holdings. Many experienced traders wait to see the price make a series of higher swing highs and higher swing lows before buying. The series of higher swing lows and highs helps identify that an uptrend may be underway and that the downtrend may be over.
Sucker rallies typically occur after a sharp decline. When prices fall significantly, it is hard for the price to immediately make new highs again. Investors are nervous, and their confidence is shaken, so when the price bounces astute investors and traders use it as a selling opportunity.
These bounces are called sucker rallies, since they are likely to be met with overwhelming selling relatively soon after they start.
Two sucker rallies occurred in 2018 after the S&P 500 witnessed a sharp decline of more than 11% in October. The S&P 500 then rallied almost 8%, but this was quickly met by more selling. The price then rallied more than 6% off the swing low, but again this was met by selling and a large drop in price.
Ultimately, the S&P 500 fell more than 20% off its September high. There is potentially a third sucker rally if counting the small (less than 4%) mid-October move higher.
Image by Sabrina Jiang (C) Investopedia 2021
On Christmas Eve the S&P 500 bottomed and started to climb. It made a series of higher swing highs and higher swing lows and eventually moved above the highs of the sucker rallies.