A Bull Trap occurs when there is a quick price increase in a downtrend. Discover the range of markets and learn how they work – with IG Academy’s online course. A popular technical indicator to identify overbought assets is the relative strength index. It is seen as a trap because the bullish investor purchases the stock, thinking it will increase in value, but is trapped with a poor-performing stock whose value is still falling. Do you have a trading or investing definition for our dictionary? You will earn 150 bonus reputation points for each definition that is accepted. After the clinical-stage biotech publicized promising data for its gene-editing treatment of a rare and fatal disease, its stock skyrocketed. “The Mexico issue with 5% tariffs in the short-term I don’t think will derail markets too much. Obviously, if we get much passed that rate as the president has threatened to the 25% rate, that quite certainly will cause markets to pull back.
Further, some of the breakout traders panic and close their long positions. These stages could have a few changes in different bull trap situations. In a nutshell, that is how a bull trap is safely traded for easy profits. Kiril Nikolaev studied Business with a major in Finance at York University and worked as a financial analyst at BMO Nesbitt Burns. Kiril has been writing financial and investment-related content for over 5 years and has been featured on many financial websites. Kiril is a CFA charter holder with over 10 years of investing experience.
How To Trade Bull Traps
Bull traps refer to fake upside breakouts after which the price makes a sudden and unexpected reversal, breaking below a well-established support level. Bull traps can be quite frustrating, especially if your strategy involves trading upside and downside breakouts, but savvy traders can also use them to their advantage. – Last but not least, bull traps often lead to large and sustained price movements in the opposite direction and sometimes even trend reversals. Waiting for a clear sign of a trend reversal could significantly increase your success rate of trading bull traps. You’ll be better off trading bull traps during times of higher liquidity, such as during the NYSE open-market hours or the NY-London session overlap in the forex market. – Again, if a correlated market doesn’t replicate the upside breakout of the market you’re trading, it’s likely a bull trap. Cross-market correlations can be used to confirm a selling opportunity and trade in the opposite direction of the bull trap.
A bull trap is most likely to occur after a long bullish trend. This is a sustained upward movement of the price that has been active for a long time. Most traders and investors are more concerned with getting out of a bull trap than settling in and executing more trades. But yes, it is indeed possible to trade during a bull trap, provided you know how to escape it first. If the asset is considered overbought, it will likely perform a bearish reversal shortly after the breakout. Essentially, this type of trap denotes a reversal against a short-lived bullish trend.
Ways To Avoid Bull Traps And Bear Traps
Bull traps are false buying signals that “trap” investors and traders who acted based on those signals. Finding bull trap chart patterns as well as key resistance zones can be really difficult, especially for novice traders. When you think that you found a bull trap, it will eventually turn out to be a true breakout to the upside. So, to find a strong resistance level you should switch to the weekly or the daily timeframes and look at the charts. Is there a peak that actually stands out from the trading channel? If there is a peak, this is your resistance level (don’t be too lazy to do this to confirm your resistance levels). A bull trap pattern typically occurs at a resistance level and is a bearish signal forming with an uptrend.
- At this point, the price rises again at F, causing bullish traders to enter long positions after seeing support at USD409.50.
- Instead, wait for a candlestick confirmation, which includes anything from a bearish engulfing pattern, evening star pattern, or bearish marubozu pattern.
- This information has been prepared by IG, a trading name of IG Markets Limited.
- Please read the Characteristics and Risks of Standardized Options before investing in options.
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. 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.
● So, the trader did not open any trade but waited for the price action. As it would be, the price experienced rejections on the upper side and came back to test the former resistance zone. Upon testing it, it closed below it, meaning an uptrend was very unlikely, so the trader expected a sell trade. ● After the retest candle, the price closed above the support level. After a short period of ranging here, it formed a huge bearish candle that engulfed the previous bearish candles. In short, price action is the surest way of reading the market and avoiding bull traps as they form. ★ If the candlesticks at the resistance zone have long wicks on the upper side, it means the bears are restraining the price from going any higher. If buy trades are open here, they will only be profitable for a short time before being pushed lower and trapped.
Try adding an indicator to the chart called “Average True Range.” Set the input parameter to “1”. This indicator will place a window with a line at the bottom of the chart that provides a range measurement for the previous candle. First of what is a bull trap all, after a steady decline prices will rally, but not very far. In the example above, Bitcoin falls 23% during its initial decline in May 2021. During the initial downtrend, prices will remain below the sloping resistance trend line.
So, with that in mind, I placed a mental stop loss at $1.68 and I was going to let the market move in its desired direction. I couldn’t believe I was caught in yet another bear trap similar to Zynga, but also that my losses were far greater. I was planning on closing half of the position on a morning pop; however, the market had other plans. I remember sitting at my desk doing my pre-market scan of open positions and seeing a trade come through at $2.50. My next real-life example is the biotechnology company Chelsea Therapeutics. This was my first trade of the New Year, so you can only imagine the psychological importance. Not to mention I had just hit another peak in my trading account; you could say I was riding on a bit of a high. I had my eye on Zynga for quite a while and decided to go long.
After topping on February 13, 2020, Bitcoin’s price began to correct lower and shaved 20% off its value. Traders then saw a bounce develop as Bitcoin recovered some of those losses. There are essentially three parts that make up the perfect bull trap. Short selling is the selling of an asset that the seller does not own. The engulfing bar and range squeezes are not commonly discussed but they happen frequently. After a tight range or a slow trend, the price suddenly makes a violent move and many orders will get triggered by the spike. The professionals are the ones who are aggressively buying and the amateurs are still happily selling, hoping that the price turns again. People in disbelieve hold on to their trades that are suddenly turning into a loss.
Best Mercado Bitcoin Alternative
Goldman Sachs, a now-sold holding of mine, reported good news, but it is hardly the leader to power the entire stock market. Moreover, the stock has been battling a significant, bearish trend of its own. Bull traps occur when an upward breakout retreats back below a resistance level. Resistance is normally associated with two/more equal highs or an earlier major high.
In the illustration above, the market is correcting lower within an initial downtrend at point 1. It often occurs in Futures, Stock markets, and Forex and Currency pairs. Some experienced traders use the chart pattern and technical analysis to look for trapped traders and try to benefit from the scenario. The first hint that a bull trap is on the way is a strong bullish trend that has been sustained for a long time, but it reacts significantly to a specific resistance zone. It means the buyers have been in control for a very long time and are most likely about to exhaust their resources. This assumption becomes valid when the price eventually enters a resistance zone.
When most people, especially a cohort of retailers make decent returns in the short term, they end up attracting a mass to indulge in similar activities with similar expectations. Unfortunately, this mass may not be equipped with a similar risk appetite as the more experienced investors. As expected, the divergence led to a complete breakdown of USD402. In this scenario, a trader using only candlestick action to enter a trade would have fallen into a bull trap. Now that you know what bear and bull traps look like, here are a few tips on how to avoid getting stuck in a trapped trade. Like its bear counterpart, a bull trap gives a false sense of price reversal. In this case, a bull trap is designed to lure unsuspecting traders into opening long positions on an asset.
The last characteristic of a bull trap setup is that it forms a range-like pattern on the resistance level. As such, one way to identify a potential bull trap is when the price makes significant stops on a resistance level after a long sustained uptrend. However, after the price reached the marked resistance level, it would slow down and pull back a little before pushing higher. As we can see, there were three tests before the bear trap eventually happened. A strong uptrend with minimal bearish interference means the buyers are pumping in everything they have. However, when they take the price to a certain resistance level, they tend to fear or respect it, and the price pulls back before going even higher.
Traders are placed short, breakout traders jump in to recover their loss, then rejoined the trend after getting stopped. So in order to do that, They pushed the price a little bit higher to break the triangle resistance line and then trapped buyers with their big sell orders. Volume indicators are very useful for identifying fakeouts and bull traps. A trade’s position size depends on your risk tolerance and the market you’re trading on. As a general rule, it’s better not to risk over 2-5 % of your capital in one trade.
Traders will use the knowledge which they have learned over countless years to identify patterns in the graph and short the stock in accordance with the patterns. One of the best ways to avoid getting caught is to avoid late entries when it comes to investing in a trend. Other things to look for are a retracement that respects the breakout level. A trader may potentially seek a higher than normal volume and bullish candlesticks on their graph before an outbreak. The stock also double-topped at the high of the day at around $3.80.