A bull trap is a market move that fools traders into thinking the price of an asset is about to rise. Traders can identify these traps by looking at price action, trading volume, and technical analysis indicators.
A real price reversal usually has substantial volume behind it, so low or no volume during a reversal can indicate a bull trap. Traders should always consider their risk tolerance before trading and only invest what they can afford to lose.
Identifying a Bull Trap
After a long bullish trend, the price of an asset will often begin to slow down as shorter candlesticks form. This is an indication that the bulls are about to run out of their resources and will start to retreat to safer territory. Traders should keep an eye on trading volume and technical analysis indicators like RSI and MACD to avoid falling prey to bull traps. Weak buying volume suggests that there isn’t much demand for the security at a particular price level and that the breakout might be false.
More experienced traders will also look for triangle patterns that appear when the price of an asset fluctuates within a smaller price area over time. If the price breaks above a resistance zone, only to quickly fall below it again, this is a classic bull trap. The resulting downward momentum will take out many of the new buyers who entered the trade, leaving the sellers with the upper hand again.
Identifying a Bear Trap
The first step in identifying a bull trap is to assess market conditions and trading volume. Traders should be aware of how much the price of an asset can rise in a short period, as this information can help them avoid falling into the trap. A low trading volume is one of the most common signs of a bull trap.
When traders see a large increase in the price of an asset, they often assume that this upward trend will continue. Unfortunately, this is often not the case and many investors fall victim to a bear trap.
The first hint that a bull trap may be approaching is a powerful upward trend that suddenly reverses in a particular resistance zone. This reversal is usually caused by institutions scooping up available assets to minimize selling pressure. This sudden dip is also known as a profit-taking or manipulation move.
Avoiding a Bull Trap
A bull trap can be spotted by a careful look at the chart, and keeping an eye on technical analysis indicators like the MACD, RSI, and Stoch. These indicators should signal a divergence early on, giving buyers plenty of time to get out of their positions before the bull trap occurs.
Another way to avoid a bull trap is by opening a short position once the trend has turned bearish, either by buying directly or by using financial derivatives such as CFDs. This can help to limit losses should the price decline even further, although this strategy comes with significant risk and is only suitable for traders with sufficient capital reserves.
It is also recommended to have a bidirectional mentality when trading, with both a bear and bull market mentality, as this can lead to greater profits in the long term. Traders that have a unidirectional mentality can fall into bull traps easily, which will result in them liquidating their positions at a loss.
Avoiding a Bear Trap
The best way to avoid a bear trap is to follow your trading plan and use proper risk management. For example, it is important to have a stop loss order set that will limit your losses in the event of a market shift. Additionally, it is a good idea to seek the advice of a financial professional and only trade what you can afford to lose.
Another important factor in avoiding a bear trap is to look for signs of a price reversal, such as an increase in price or a change in the market’s trend. You should also consider the amount of trading volume, as a low volume may indicate that the current price is not sustainable.
A bear trap is a false signal that causes traders and investors to sell an asset at low prices. As a result, they suffer losses or missed opportunities. Traders can protect themselves against this type of trap by paying attention to technical indicators and studying reversal candlestick patterns.