Traps

Source: Investopedia

What is a Bull Trap?

A bull trap is a false signal, referring to a declining trend in a stock, index or other security that reverses after a convincing rally and breaks a prior support level. The move “traps” traders or investors that acted on the buy signal and generates losses on resulting long positions. A bull trap may also refer to a whipsaw pattern.

KEY TAKEAWAYS

  • A bull trap denotes a reversal that forces market participants on the wrong side of price action to exit positions with unexpected losses.
  • Bull traps occur when buyers fail to support a rally above a breakout level.
  • Traders and investors can lower the frequency of bull traps by seeking confirmation following a breakout through technical indicators and/or pattern divergences.
  • The opposite of a bull trap is a bear trap, which occurs when sellers fail to press a decline below a breakdown level.

What Does a Bull Trap Tell You?

A bull trap occurs when a trader or investor buys a security that breaks out above a resistance level – a common technical analysis-based strategy. While many breakouts are followed by strong moves higher, the security may quickly reverse direction. These are known as “bull traps” because traders and investors who bought the breakout are “trapped” in the trade.

Traders and investors can avoid bull traps by looking for confirmations following a breakout. For example, a trader may look for higher than average volume and bullish candlesticks following a breakout to confirm that price is likely to move higher. A breakout that generates low volume and indecisive candlesticks – such as a doji star – could be a sign of a bull trap.

From a psychological standpoint, bull traps occur when bulls fail to support a rally above a breakout level, which could be due to a lack of momentum and/or profit-taking. Bears may jump on the opportunity to sell the security if they see divergences, dropping prices below resistance levels, which can then trigger stop-loss orders.

The best way to handle bull traps is to recognize warning signs ahead of time, such as low volume breakouts, and exit the trade as quickly as possible if a bull trap is suspected. Stop-loss orders can be helpful in these circumstances, especially if the market is moving quickly, to avoid letting emotion drive decision making.

Example of How Bull Trap Works

In this example, the security sells off and hits a new 52-week low before rebounding sharply on high volume and lifting into trendline resistance. Many traders and investors jump on to the move, anticipating a breakout above trendline resistance but the security reverses at resistance and turns sharply lower from these levels. New bulls get trapped in long trades and incur rapid losses, unless aggressive risk management techniques are undertaken.

The trader or investor could have avoided the bull trap by waiting for a breakout to unfold before purchasing the security, or at least mitigated losses by setting a tight stop-loss order just below the breakout level.SPONSORED

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Gravestone Doji

A gravestone doji is a bearish reversal candlestick pattern formed when the open, low, and closing prices are all near each other with a long upper shadow. more

Tri-Star Definition

A tri-star is a three line candlestick pattern that can signal a possible reversal in the current trend, be it bullish or bearish. more

Breakout Definition and Example

A breakout is the movement of the price of an asset through an identified level of support or resistance. Breakouts are used by some traders to signal a buying or selling opportunity. more

Doji

A doji is a name for a session in which the candlestick for a security has an open and close that are virtually equal and are often components in patterns more

Harami Cross Definition and Example

A harami cross is a candlestick pattern that consists of a large candlestick followed by a doji. Sometimes it signals the start of a trend reversal. more

Spinning Top Candlestick Definition and Example

A spinning top is a candlestick pattern with a short real body that’s vertically centered between long upper and lower shadows. With neither buyers or sellers able to gain the upper hand, a spinning top shows indecision. more


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 denotes the opposite of this phenomenon, in which a false reversal of a declining price trend takes place. In either case, these traps can tempt investors into making decisions based on anticipation of price movements which do not end up taking place.

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

How Does a Bear Trap Work?

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.

KEY TAKEAWAYS

  • A bear trap can occur in all types of 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.

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.SPONSORED

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Bull Trap Definition
A bull trap is a false signal, referring to a declining trend in a stock, index or other security that reverses after a convincing rally and breaks a prior support level. more

Bull DefinitionA bull is an investor who invests in a security expecting that the price will rise. more

Inverse Head And ShouldersAn inverse head and shoulders, also called a head and shoulders bottom, is inverted with the head and shoulders top used to predict reversals in downtrends. more

Breakdown Definition

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