Bear and bull traps are common events in the financial market. They refer to sudden moves that tempt traders to buy and sell and then lead to another sudden reversal.
In this article, we will explain the bear trap, how it works, how to identify it, and how to position yourself well.
What is a bear trap?
A bear trap, also known as a bear trap pattern, is a situation in which A financial asset suddenly collapsesattracts short sellers, and bounces.
A short seller is a trader who seeks to profit when the price of an asset falls. Includes borrowing shares and converting them into cash Waiting for the price to drop.
So, when a bear trap It usually happens lead to loss. in Intense situation, this trap can lead margin call, where the broker requires additional capital to cover the loss. If no additional capital is added, the broker will stop trading.
A good example of this is shown in the chart below. As you can see, the stock made a strong bearish breakout and then resumed the short uptrend within a short period.
Related “ How to identify false breakouts in day trading
How does this trading trap work
There is a common question among many traders How does a bear trap work?. This happens when the stock is either in merge stage, when you are in upward trendAnd the or When the formed a pattern Like a descending triangle or double bottom pattern.
In this case, the arrow It will have a strong drop Then it attracted many traders who believed that a new downtrend had begun. after thisThe stock and then A sharp shift occurs It starts in a new uptrend or continues in the current trend.
Bear Trap vs Bull Trap
The opposite of a bear trap is a bull trap. The term bull trap refers to a situation in which a financial asset such as a stock or cryptocurrency is nailsand then Turns around and resumes downtrend. As such, people who buy the initial pop are usually left with big losses to deal with.
Bull and bear traps Happens in different market periods. For example, traps can occur when a stock is moving in an upward or downward direction. It can also occur when the asset is in the consolidation phase or when it is forming a chart pattern.
A good example of a bull trap is shown in the chart below. You see, the stock made a strong bullish gap, tempted some people to buy, and then a strong reversal occurred.
Related ” Do you fall into this day trading trap?
Bear trap for short selling
Another common question is on The difference between a bear trap and a short sale. The first happens when the stock makes a downside breakout and then suddenly turns around.
on the other side, short sale It is the process of selling a stock and waiting for a profit with a decrease in its price. It is the opposite process of buying a stock and taking advantage of it as its price increases.
As can be easily guessed, short sellers should avoid falling into a bear trap. Or it must be good enough to anticipate a reversal (not an easy task) to the downside.
Causes of a bear trap
This situation can be caused by several factors. In most cases, a bear trap occurs when there is a major event or economic data In the market.
for example, in stockHe. She It can happen then publish company profitsmaking a major acquisition, and launching a new product.
For example, if a company posts strong earnings, the theory is that its stock should rise sharply. Why not? After all, the results are positive.
However, in most cases, Arrow can go down As institutional traders look for many things such as forward guidance.
Similarly, in currencies, the EUR / USD Husband can rise after The feed it delivers tight interest rate resolution. In commodities, the price of crude oil could fall after the US releases a rise in inventories.
Breaking key levels
Another reason for a bear trap is when a Inventory is moving below the key support level And the Then a new uptrend begins Instead of continuing to the downside.
A bear trap can also occur in a period when the stock is in an uptrend. In this case, the stock will fall sharply and short, and then resume the upward trend.
How to identify a bear trap
In all fairness, Identifying a bear trap is relatively difficult Whereas, the asset can continue in a downtrend after it has occurred.
Some traders still use several methods to identify these patterns.
For example, some traders use indicators to identify differences. Divergence refers to a situation in which the price of an asset is moving in the opposite direction of an indicator (or any other type of data).
Some of the top Divergence Indicators The ones to use are the Relative Strength Index (RSI), MACD, and the Relative Strength Index (RVI).
Another approach is to use market size To locate a bear trap. Most brokers provide tools that show the size of the assets.
A closer look at this data can show you whether the bearish breakout will continue. In most cases, if it is bearish go ahead he is Not supported by sizeit is likely to be a bear trap.
You can also use tools like Fibonacci Retracements and Andrews Pitchfork to predict whether or not a breakout will continue.
Strategies to avoid it
There are several strategies you can use to avoid a bear trap. First, you can embrace patience When there is a downside breakout. Instead of rushing to sell shortYou can wait for the hack to be confirmed.
In most cases, A breakout is usually accompanied by a breakout and retest pattern. As such, it is ideal to wait before executing a sell trade after the downside breakout.
Second, you can Avoid short selling When the trading volume is low. Furthermore, since shorting is too risky to be long, you can avoid doing it entirely.
Related “ Short selling in a bear market
Bear traps are common in the market. And in most cases, it is often occupied by experienced and inexperienced traders.
In this article, we took a look at what a bear trap is, its causes, and how to identify it in the market. Therefore, you should understand the risks (and benefits) of these types of traps.
Our advice is to avoid entering the market at such times unless you are 100% sure because the consequences can be painful.
Useful external resources
- Is a bear trap the same as a short squeeze? – kora