A bull trap is one of the reasons why traders should be wary of any abrupt change in the price of an asset as soon as it completes a breakout, which is a price movement below the support level.
Unfortunately, most retail investors, especially in the cryptocurrency space, expect that the breakout will always be stronger than rising prices, which is not always the case.
What is a bull trap?
Bull Trap is a classic case of a false breakthrough. In general, buyers enter the trade with a firm confidence in the positive side. However, sometimes stocks are unable to ensure an upward movement and instead reach a stop loss or level of support for the trader.
This is a type of value trap where the investor looks at the fundamentals and the market price of the stock, and it seems that the stock is valued at a discount (cheap to own), but in the end it is not. The illusion makes an investor think that he will invest in stocks and win the market, but will provide
When does a bull trap occur?
Bull traps tend to occur in downturns or bear markets as prices begin to rise. Buyers may view growth as a possible end to a downtrend.
A technical signal, such as a price increase above the resistance level, can help increase this confidence. These buyers could jump, but then were quickly overwhelmed by sellers as the downward trend continues.
How can you avoid bull traps?
Bull traps can be avoided by using additional precautions, such as finding additional signals to confirm a long run after the initial break above resistance. Breakthroughs combined with low trade are often a sign of a future trap.
Because bull traps arise when bull traders are unable to maintain an asset growth trend after a breakout resistance, low trading volumes during breakouts are good indicators of this. Therefore, in order not to fall victim to the bull trap, always consider other indicators, such as trading volume and subsequent price movements, before opening new positions after the price break.
Most experienced market players call this “confirmation”, by which the trader monitors the movement of the asset in the next period of time before deciding whether to introduce new positions.
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What is a bull trap chart?
The bull trap chart is a bearish signal that is formed during an uptrend. The most common place for a bull trap is a zone / zone of high resistance.
Range occurs when the price moves up and down within a certain level of support and resistance. This usually means that both buyers and sellers are struggling to dominate the market, but neither side seems to be finding enough momentum to come out on top.
Buyers are actively defending the level of support and trying to raise the price. On the other hand, sellers are actively defending the level of resistance and trying to push the price down. In the end, one side wins for a certain period of time.
How traders get into Bull Trap
- Prelude: a long sale when people lose opportunities to make a profit and / or become too greedy and want more.
- Then the price creates a new wave of trends that lures people to new positions. It seems that the price is starting a new wave of the trend, breaking the previous lows.
- The price is a bit in favor of those “detained” traders, creating a sense of confidence and security.
- The price returns up. People who do not believe are holding on to their operations, which suddenly turn into losses. Others add their losses, hoping to reduce the average. Professionals are buying aggressively, and amateurs are still happy to sell, hoping that the price will change again.
- The price continues to rise and trapped short traders are now facing huge losses. Most of them are forced out of their long trades, which mean they have to buy, which accelerates growth.
As you can see, a trap for bulls or bears is more than just a template, but it is a way to visualize and understand how the average trader approaches the markets and why professionals usually always win.
What is bull trap stock trading?
When the action breaks through, it is important not to see the movement in isolation. This is a positive sign only if the economy is moving in the direction of growth.
The economy as a whole may be bearish, but there may be stable sectors; if the exploding stock belongs to such a sector, it is safe to invest in such stocks. Such trend studies help strengthen and increase the confidence of traders.
In addition, when stocks explode, it is safer to wait and watch while prices are set and maintained at justified levels. In addition, it is useful to be meticulous about key ratios and to conduct technical and fundamental assessments.
The positive trend in the index from which the shares will be selected is also a good sign of confidence that growth will continue.
How to avoid stock trading bull trap
Investors need to evaluate several indicators before confirming a purchase decision. You can take a data set to track historical stock price changes. This data can then be used to estimate moving averages by estimating averages for smaller subsets of data.
This is a common technical analysis that is conducted to study stocks. This method is useful because it can filter out random noise in short-term price volatility. This method helps to determine the direction of the trend and the degree of stability.
A candlestick is a visual representation of information about the movement of the price of an asset or stock. Candle charts are one of the most popular types of technical analysis because they allow traders to quickly estimate price data.
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Spoting a bull trap from Japanese candlesticks
To understand the candlestick chart, it is important to understand the three elements – body, wick and color. The body shows the range between the opening and closing prices for the trading period. The wick indicates the highest and lowest price for the period.
Green or red indicates an increase or decrease in price, respectively. Once the price crosses the resistance value, testing typical candlestick models, such as the bull hammer, inverse hammer, bull absorption, piercing line, morning star, and three white soldiers, could be a step toward further investing in stocks.
Using the RSI to spot a bull trap
The Relative Strength Index (RSI) is a technical analysis indicator that examines the degree of recent price fluctuations to determine whether a stock or other asset has been repurchased or resold. The RSI is in the range of 0 to 100. When the RSI rises above 70, it is considered overbought, and when it falls below 30, it is considered oversold.
The Moving Average Convergence / Divergence Indicator (MACD) is also used for technical analysis. On the graph, it looks like two oscillating lines without restrictions.
The indicator is considered bullish when the MACD line crosses over the signal line. The indicator is considered bearish when the MACD line intersects below the signal line.
Bull trap vs bear trap
A bull or bear trap is first and foremost a charting scheme that is quite common, but traders tend to ignore it just to see how so-called profits turn into losses. Even traders who use technical indicators in their trading will face a bull trap or a bear trap model.
The use of technical indicators does not guarantee that you will be able to avoid these patterns. Therefore, the best way to avoid or trade models of bull and bear traps is to first clearly understand.
A bear trap is the opposite of a bull trap. This is a false sign of a reversal from an upward to a downward trend.
This forces traders to open short positions, hoping to profit from lower asset prices. In addition, it may force them to sell their shares or cryptocurrency assets to make a profit and prevent losses. However, the asset continues to grow, and bears suffer losses or opportunity costs.
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How to trade a bull trap successfully
Use tight Stop-Loss
Using a hard stop loss helps prevent large capital losses in breakthrough trade. You need to put a stop loss after opening a long position or have a mental stop loss to use when needed.
Placing stop-loss orders in these transactions is a bit more risky. Because stop loss hunters usually know where most traders put their stop losses. Therefore, they tend to cause a rapid fall in prices and fall into the stop loss.
Therefore, it is better to have a mental stop loss and use it when you learn that the trend is no longer bullish and the price will soon fall.
Open a short position
You can open a short position, but only after confirming the current downtrend. If you had taken the time to confirm a previous trading trend, you probably wouldn’t have fallen into the bull trap. Once the market changes direction and you confirm the trend, open a short position. In this way, you can make some profit to compensate for previous losses.
Ideally, this should only be done in highly liquid markets. Also, think about doing this with investment instruments that do not require you to own directly after taking office. You want to get in and out quickly if the market changes direction again.
Study technical analysis patterns
Studying technical analysis and chart models will help you identify some trading settings with a high probability of success. In the ascending triangle chart model, there is a high probability that the price will break the line of resistance and go higher.
So, if you know these bullish chart models, it will help you better understand the situation and adjust your expectations about opening a long position near the line of resistance.
Proper risk management
Trade breakthroughs have their own risk, and we have mentioned some of them in the above sections. To avoid the bull trap and large capital losses, you should use the correct position size and never open a position with all the capital in your account at once.
The size of the transaction position depends on your risk tolerance and the market in which you trade. As a rule, it is better not to risk more than 2-5% of your capital in one trade.
In addition, you can increase your position to reduce the risk. For example, you can buy 50% up to the resistance level and buy the remaining 50% after the breakout to reduce your losses.
Understand market sentiment
No matter what market (for example, Forex, Promotion, Cryptocurrency, Commodity, etc.) you are going to trade, you need to know the dynamics of the market well enough to understand its mood.
One of the most important skills for a trader is to understand market sentiment and whether the general trend is changing from bullish to bearish or not.
In fact, bull traps are more common in bear markets because there is not enough buying volume in these conditions to force the price to break the line of resistance and climb higher.
Buy the Pullback
If you are a position trader or a swing trader rather than a day trader, then you have a clear choice and you are just buying a price rollback. This technique is mainly used by professional traders to prevent bull traps.
Instead of opening a long position near the resistance zone, you should wait until the price overcomes this resistance, and then place a purchase order after it has returned to the appropriate level of support.
Bull Trap FAQs
How long should a bull trap last before I place a trade?
If you’ve been watching the chart until the bull trap appears, you can just wait for the price to check the resistance again. Wait for a few candles to test the resistance within the range, and then place the stop loss just below the support level before placing a buy order.
What is the time frame for estimating the moving average in the stock market?
The period of retrospective analysis or the time frame for estimating the moving average depends on the trader, but ideally, a 50-day, 100-day and 200-day moving average would be sufficient to explain.
Can you identify a bull trap with moving averages?
Moving averages may indicate resistance – in the case of a positive trend, a moving average may indicate a minimum value that prices should not exceed, while for a downward trend it will be an indicator of the upper limit at which prices will fall.
