Price trap is a term that refers to a signal that deceives investors into thinking that a price trend has ended and the market may soon enter a correction phase, causing investors to hastily sell off stocks. Bull traps and Bear traps can cause significant damages to investors. So, what are Bull traps and Bear traps? How to avoid these two price traps, or if you have fallen into a trap, how to limit losses?

What are Bull Trap and Bear Trap?

A bull trap (also known as a price increase trap) is a bullish reversal signal in a declining market. This signal typically appears at resistance levels, when the price starts to break through this barrier, investors are excited thinking they have caught the new trend and quickly place BUY orders in the hope that the price will reverse upwards. But shortly thereafter, the price turns back and continues to decline, stop loss is wiped out.

A bear trap (also known as a price drop trap) is a bearish reversal signal in a market that is trending upwards. When the price begins to break through support levels, investors believe that the market will reverse downwards and quickly place SELL orders in anticipation of a new trend. But unfortunately, the price only drops slightly before quickly reversing upwards and continuing the initial bullish trend.

When do Bear Trap and Bull Trap occur?

Both bull traps and bear traps can cause significant losses for investors. Therefore, during trading, investors need to know when they occur to take timely preventive measures. Here are some common times when Bull traps and Bear traps occur:

Bear trap

  • When manipulated by sharks

Investors with large capital, referred to as 'sharks', have the capacity to manipulate the market and create a Bear Trap signal. They continuously place buy and sell orders to create false supply and demand with the aim of driving stock prices down. Sometimes, they will combine this with negative news to mislead inexperienced investors into placing SELL orders. Taking advantage of this opportunity, the sharks will buy at low prices to reap profits.

  • When investors want to take profits.

In some cases, a large number of investors feel that the market has risen too much and want to take profits. This creates a temporary price correction effect. Especially before holidays when trading is often not allowed, investors will rush to close positions. After this effect ends, the price will again follow the original direction.

Bull trap

  • Large investors manipulate the market: 'Sharks' use money to continuously buy a stock to create a false price surge. Inexperienced investors see the price rising and execute buy orders. When the money has reached the expected threshold, large investors start to sell off their holdings to take profits.

  • Price increase effect: this is also a point that can easily trap investors. Taking advantage of the crowd's psychology, large players will place buy orders at the same time to create a temporary price increase phenomenon. Inexperienced investors will then buy in, and when the buying slows down, the price will revert to a downward trend.

  • Being affected by unexpected events: This occurs when the market suddenly has an unpredictable event. At that time, investors tend to buy heavily, forming a temporary price increase phenomenon.

Market Psychology Behind Bear Trap and Bull Trap

For a bull trap, when the price rises and begins to approach resistance, two scenarios can occur: either the price reverses or it breaks through the resistance and continues upward. At this point, some investors believe that the price will breakout and reverse upwards, so they place Buy orders at any cost (Market orders) to ride the trend, causing the price to break through the resistance level. Others expect a pullback before the price increases, so they place limit buy orders, which diminishes the upward momentum.

At that time, a consolidation phase occurs, the price drops slightly, and market investors begin to panic, with some closing positions to limit losses which continues to push the price down. When the price hits these investors' stop losses, they quickly start selling off, further driving the price lower. This is the result of a Bull trap.

Additionally, during a strong bearish trend, outside investors often regret not entering the market sooner, especially this is the psychology of most new, inexperienced investors.

When the price starts breaking through resistance levels and even rises sharply, it indicates that the bearish trend is beginning to exhaust. This signal somewhat satisfies the psychology of those investors, who quickly jump in to recover missed profits. Taking advantage of this inexperienced psychology, a trap has been set by professional investors. When these inexperienced investors simultaneously place BUY orders, causing the price to rise, seasoned investors are waiting to sell at a higher price. The excessive selling pressure causes the price to reverse downward. At that point, the 'weak' souls also begin to close their positions to correct their mistakes, pushing the price down even further.

How to Identify Bull Trap and Bear Trap

Identifying whether a breakout is a price trap or a genuine breakout signal is very useful for investors to seize opportunities for profit or avoid risks.

Here are some of the most popular tools: Fibonacci, price action, and convergence/divergence signals from indicators.

General steps to identify whether a breakout is a price trap or a genuine breakout:

  • Step 1: Identify important price zones and resistance/support levels.

  • Step 2: When the price begins to break through resistance or support, use identification tools to determine whether the price will reverse or not.

Note: the price may break the level and reverse in the same trading session or may also break the level and return after a few sessions.

  • Fibonacci

Fibonacci is one of the tools that has been very effective in identifying price traps. When the price breaks through resistance or support levels, the breakout signal can also be a bull trap or bear trap if the price halts at one of Fibonacci's key ratios.

  • Divergence or convergence between the indicator and the price.

Indicators used to identify bull traps or bear traps are usually RSI, MACD, Stochastic, etc. In this article, Mytrade will illustrate with the MACD indicator.

The breakout price will act as a support level, forecasting the likelihood of a bearish market reversal. However, if a convergence signal appears between the price and the MACD line, along with a strong bullish candle longer than the previous bearish breakout candle, it indicates that a reversal is highly unlikely. Investors may determine that this is merely a bear trap to avoid placing Sell orders in this case.

  • Price action

When the market breaks through important price levels, determine the price behavior through candlestick patterns and price patterns. If the price action aligns with the breakout, that is a breakout signal and the market will reverse; conversely, it could just be a bull trap or bear trap.

The market is in an uptrend, but when the price starts to drop and break through the support level. If investors see the price plummet and immediately place Sell orders, it can be very risky. In this case, you should wait for the breakout candle to close and observe it along with a few subsequent trading sessions. In this situation, the breakout candle is a bullish pin bar with a fairly long tail, indicating strong buying pressure and that the price cannot drop further. You can also predict that this is a bear trap through price action analysis.

The price has broken through the trendline twice, acting as a support level. If investors rush, they will easily place Sell orders thinking the price will truly break this support and drop sharply to reverse the trend. However, shortly thereafter, a Bullish Engulfing pattern is established and the price quickly rises again. This is a bear trap.

Effective Ways to Avoid Bull Trap and Bear Trap

Bear Trap and Bull Trap are phenomena of false price fluctuations and usually only occur for a short period. Therefore, during trading, investors need to actively take preventive measures against price traps with the following strategies:

  • Build a strong knowledge foundation: When you are well-equipped with knowledge, you will understand the market's shape or know which factors can influence the price, thus avoiding price traps.

  • Know how to manage capital most effectively: This not only helps you avoid price traps but is also crucial in every trade. It is best to use appropriate leverage and absolutely avoid investing heavily when uncertain. Additionally, always remember to set stop-loss and take-profit in every transaction.

  • Have a good understanding of the market: Be clear about trading principles and market perception, and also know how to use indicators to perform technical analysis. From there, you will be able to identify real reversal signals and price traps to avoid.

Conclusion

Bear Trap and Bull Trap occur continuously in financial markets; therefore, understanding information about price traps is extremely important to minimize trading risks. Thus, I hope that the sharing of what Bear Trap is by Mytrade will help you gain useful knowledge and invest effectively.

DYOR! #Write2Win #Write&Earn $BTC