Bear and Bull Traps – Use ‘Em, Don’t be Abused by ‘Em

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Bear and Bull Traps – Use ‘Em, Don’t be Abused by ‘Em

The price breaks out in the direction you expect, and you jump aboard with a trade. Moments later the breakout has failed and you find yourself in a trade that is rapidly accelerating in the opposite direction. Welcome to bull traps and bear traps; terms used to describe an event where traders are trapped into thinking one thing is about to happen, only to have a bait-and-switched pulled on them. Here’s what bear and bull traps look like, and how to use them instead of being victim to them.

Bear Traps and Bull Traps

Bear and bull traps occur in all markets and on all time frames. I see them when I day trade futures and I see them in the forex market. When London opens in the forex market it is very common to see a bull or bear trap. Typically there is low volatility overnight, and when London opens the price moves outside that range (on one side or the other) only to move back the other way shortly after. Traders looking at the overnight session may view this as a breakout, and it may be, but it also could be a trap.

Figure 1 shows a EURUSD 15 minute chart. The overnight range is marked with horizontal lines, showing the overnight high and low. As London opens (highlighted in yellow) the price just edges above the overnight high.

Since buying on new highs is a common strategy (not one I endorse) it is likely many traders get caught by this type of price move–buying on the new high only to have it quickly move back the other way. This is called a “bull trap” because buyers (also called bulls) are expecting the price to go higher and buying in anticipation; it’s a trap because it didn’t work out.

Figure 1. EURUSD 15 Minute Chart

The price then also breaks the overnight low, by a larger margin, but then it too aggressively moves back the other direction–this traps the bears or sellers, and is therefore called a “bear trap.” This was a particularly sinister day for those buying on new highs or selling on new lows because there is yet another bull trap, as the price rallies above the former high only to quickly reverse. The price then finally settles into a downtrend.

Dealing with Traps

There are several ways to deal with traps. Before getting into them though it is important to point out that bear and bull traps are quite common. Since they are common, it is important to accept that it is likely you’ll be caught in one at some point, and you do have options.

1. The first option is to do nothing. If you have a winning trading plan, losing trades happen. Accept that you may occasionally get stuck in a bear or bull trap and accept it.

2. Reverse. If you are an active trader, and are comfortable with it, you can “flip” your position. Get out of the trade you’re in and go the other direction. For example, you sell a breakout to the downside, the price moves only slightly lower and then snaps back the other direction. Exit the short or put, and go long or buy a call.

If you can’t exit your position, you may simply be able to “hedge.” For example, if you have a bought a put, you can buy a call once you see the bear trap is occurring. The danger here is that it is possible to end up with two losses instead of just one.

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3. Don’t buy breakouts to new highs, or sell breakouts to new lows. This third option involves altering your strategies to avoid trade setups which often result in bull and bear traps. While it is a personal choice–and definitely not the only way to trade– I don’t buy when a new high occurs or sell when a new low occurs. During a downtrend, for example, I sell during pullbacks higher and exit just beyond former lows (basically I am getting out on those traders who are just entering on the new low). In an uptrend, I enter during pullbacks lower and exit the trade usually just beyond a former high.

4. Watch for traps and trade them instead of the breakout. If you are frustrated with trading breakouts that fail (bull and bear traps) then don’t trade the breakout. Instead, simply watch for a bull or bear trap and trade it. For example, you see a small range develop. The price pops above the range only to quickly drop back into the range and continue dropping. Enter a sell or order or buy a put to take advantage of the fact that the price couldn’t break out of the range higher, and is likely to head down and test the low of the range.

Expectations that don’t materialize are part of trading. Accept it and decide on a game plan for how you will handle these events. Most traders just get angry at the market; don’t be one of these traders. There are other options which allow you to turn a problem or “trap” into an advantage. No matter what method you choose, make sure to test it and assure its profitability over many trades before using the method with real money.

Bear and Bull Traps – Use ‘Em, Don’t be Abused by ‘Em

What is a Bull Trap and a Bear Trap? These are key terminologies derived from the stock market industry which can also be applied in cryptocurrency trading. Whether traders are professional or inexperienced, these events are common and could potentially cost a lot if neither one is careful.

WHAT IS A BULL TRAP

A Bull Trap occurs when there is a quick price increase in a downtrend.
The false signal will show the asset’s (cryptoccureny or index) downtrend reversing its direction in expectation that trend will meet or breakout above the resistance level. During its sudden incline trend, investors or traders would often be lured to buy or open long on the asset, anticipating for the breakout. However, the trend reverses again after a short period of time and exposes that the value of the cryptocurrency/index is continuing to decline. Unfortunately for the bullish traders and investors, they are trapped in the trade and experience losses as a result.

WHAT IS A BEAR TRAP

A Bear Trap occurs when there is a quick price decrease in an uptrend.
The false signal will show the asset’s (cryptoccureny or index) uptrend reversing its direction towards a downtrend. This entices traders to want to quickly close their positions to avoid further loses. Some would quickly open short positions in hope that they would make profit from the decline in value, when in fact the trend suddenly reverses again and continues to incline.

CAUSES OF BULL TRAPS OR BEAR TRAPS

According to Perfect Trend System, there is no specific and clear evidence that claims a certain action in the market could result in bull and bear traps. What we can evidently pick up from is that there is a pattern in when these events occur. For example, bull trap is commonly expected near the tip of an uptrend while the bear trap is near the bottom of the downtrend.
Perfect Trend System has also noted that the rapid price action could be affected by the traps themselves. The influence they have on people’s market actions and behaviors could build further momentum for future bull and bear traps to occur again.

6 WAYS TO AVOID BULL TRAPS AND BEAR TRAPS

Whether you are a professional or a new trader, you can practice the following habits to avoid falling into the bull or bear traps.

  1. Check the Volume

If there is a change in the asset value but the volume remains consistent, then there is a possibility that a trap is occurring.

  1. Look for RSI divergence

RSI (Relative Strength Indicator) ranges between 0 to 100 and it’s a momentum indicator that charts the strength and weakness of an asset’s price. RSI 75 indicates overbought conditions. As price moves up, RSI increases if there is momentum and support behind the price increase. Similarly, RSI typically decreases when price moves downward.
Divergence occurs when price and RSI move in opposite directions. This suggests that the price movement is weak and not backed by significant momentum.
In the BitOrb Testnet’s TradingView chart, users can track the RSI and visualize the pattern against the asset price.

Source: Tradingview Chart with RSI (www.testnet.bitorb.com)

In the BitOrb exchange, traders can place orders based on the RSI indicators. You can create conditional orders using the Orchestrator for when you feel RSI becomes oversold and automatically open long positions.

  1. Check the news

The news plays a significant role in the sentiments of the market towards an asset. If there is a sudden price movement with average volume, traders can check the news to be sure of making any trading actions.

  1. Use stop-loss orders

Even though you did your research, you can never be completely confident of your trade decision because the market could go against you. Hence, you can use a stop-loss to limit the loss allowance and hedge your position.

  1. Trade only in the direction of the main trend

Trading against the main trend requires a higher level of expertise and understanding of trading the respective markets. This depends on the risk appetite of the trader whether they are willing to trade against the market trend and newer traders are typically advised to follow the basic trends.

  1. Check the next few candlesticks after breakout

Even though a breakout occurs, traders can always check the candlesticks following the breakout to see whether it’s going to be a continuing trend or just a one-off event.

At the end of the day, even if you do fall into the bear or bull traps, don’t panic and trust what you have learned. Carry forward your new knowledge and try to not be the weak hands next time ��

Bear Trap

What is a Bear Trap?

A bear trap is a technical pattern that occurs when the performance of a stock, index, or other financial instrument incorrectly signals a reversal of a rising price trend. A bull trap is thus a false reversal of a declining price trend. Bear traps can tempt investors into taking long positions based on anticipation of price movements which do not end up taking place.

Key Takeaways

  • A bear trap is a false technical indication of a reversal from a down- to an up-market that can lure unsuspecting investors.
  • These can occur in all types of asset markets, including equities, futures, bonds, and currencies.
  • A bear trap is often triggered by a decline that induces market participants to open short sales, which then lose value in a reversal when shorts are forced to cover.

How Does a Bear Trap Work?

A bear trap can prompt a market participant to expect a decline in the value of a financial instrument, prompting the execution of a short position on the asset. However, the value of the asset stays flat or rallies in this scenario and the participant is forced to incur a loss. A bullish trader may sell a declining asset in order to retain profits while a bearish trader may attempt to short that asset, with the intention of buying it back after the price has dropped to a certain level. If that downward trend never occurs or reverses after a brief period, the price reversal is identified as a bear trap.

Market participants often rely on technical patterns to analyze market trends and to evaluate investment strategies. Technical traders attempt to identify bear traps and avoid them by using a variety of analytical tools that include Fibonacci retracements, relative strength oscillators and volume indicators. These tools can help traders understand and predict whether the current price trend of a security is legitimate and sustainable.

Bear Traps & Short Selling

A bear is an investor or trader in the financial markets who believes that the price of a security is about to decline. Bears may also believe that the overall direction of a financial market may be in decline. A bearish investment strategy attempts to profit from the decline in price of an asset and a short position is often executed to implement this strategy.

A short position is a trading technique that borrows shares or contracts of an asset from a broker through a margin account. The investor sells those borrowed instruments, with the intention of buying them back when the price drops, booking a profit from the decline. When a bearish investor incorrectly identifies the decline in price, the risk of getting caught in a bear trap increases.

Short sellers are compelled to cover positions as prices rise in order to minimize losses. A subsequent increase in buying activity can initiate further upside, which can continue to fuel price momentum. After short sellers purchase the instruments required to cover their short positions, the upward momentum of the asset tends to decrease.

A short seller risks maximizing the loss or triggering a margin call when the value of a security, index or other financial instrument continues to rise. An investor can minimize damage from bull traps by placing stop losses when executing market orders.

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