Forex Education

The Bull Trap Trading Strategy Guide

Sure enough, Bitcoin reversed and fell through the old low two days later. This break below the old low led to a 58% collapse in the pricing over the next five days. So, remember if the market goes against you in a violent way, your stop thresholds have been wildly exceeded and you feel complete hopelessness. Remember to take a deep breath, relax and manage the trade.

What’s a bull trap in stocks?

So, what is a bull trap? A bull trap fools some traders into thinking a market or an individual stock price is done falling and that it's a good time to buy. But then it turns out it's not a good time, because the price soon resumes its descent, catching buyers in a money-losing trap.

They reach their max loss on that position and don’t have a stop loss. Instead of cutting their losses and exiting, they try to “win back” some of their losses tactically. As such, a rational risk per trade, measured as a percentage of your account is required. Usually, the price is parabolic, and the fundamentals arguably don’t support the current valuation, at least in the eyes of value-minded shorts. These chart patterns, and more, are covered in our guide to the 11 most essential stock chart patterns. Use our product library to pull up charts of assets and find one that is in a downtreUse our product library to pull up charts of assets and find one that is in a downtrend.

Improving Confidence Levels

When the price breaks above the previous support, you should think about a long trade . If the candlestick forms, you can place a Buy Stop limit order. The entry level is several pips above the bullish candlestick’s high . There are several indicators that are used to provide divergence signals.

News, whether it’s good or bad, can have a significant emotional effect on inexperienced traders and lead to poor irrational trading decisions. Once again, candlestick trading would’ve suggested further bull movement following the USD7,900 retest at J. However, this subsequent move back up to USD8,200 had very little buy support, and price eventually broke downward back to USD6000.

As the stop loss is triggered, more sellers are added to the market. This negative feedback loop generates strong downward momentum on prices, and the market moves very swiftly to the downside. Then, traders anticipate the end of the correction and buy with the hopes of catching a good entry in the cryptocurrency atpoint 2.

The rise in price lures many buyers into the market, but before they can make a significant profit, the price reverses and continues as a downtrend. Secondly, a bull trap will experience a false rebound that is weak with no momentum. As a result, the market will have a difficult time breaking above technical resistance levels. These zones are horizontal resistance levels, at previous highs and lows, which the market cannot break. A bull trap occurs when a false rebound traps bullish traders into long positions.

The most famous and reliable ones are RSI, MACD, and Awesome Oscillator. If you don’t know what divergence is, we’ll give you a brief definition. You may have heard of a bull trap, but if you haven’t, we recently covered this topic in an article.

Types of bull and bear traps

James Chen, CMT is an expert trader, investment adviser, and global market strategist. Ethereum eventually proved this was a bull trap pattern, as prices fell to retest the old low at $3,124. After that test failed, prices collapsed 40% in a short period — in this case, just a matter of hours.

The traders are forced to exit the trade with losses or remain trapped in a long position. Stop-loss orders can be helpful in these circumstances, especially if the market is moving quickly, to avoid letting emotion drive decision-making. A bull trap pattern frequently occurs in crypto markets, as it is a false breakout signal to bulls that a rally is underway. In reality, the trend is expected to go lower, and the market continues to seek out cheaper pricing. The difference between the two is that bull traps put traders into losing long positions while bear straps put traders in short positions. Bull traps occur in bear markets when traders are trying to pick bottoms.

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You should consider whether you understand how spread bets and CFDs work and whether you can afford to take the high risk of losing your money. Impatient traders would have jumped into the trade as soon as it broke the trend line, and thus, they would have gotten trapped. The collective forex flags and pennants selling or buying of a particular token affects the price, temporarily causing it to move in an opposite direction. During this short move, some investors who believe the market is already changing direction will be forced to respond to the market’s move and thus get trapped.

Avoid opening short positions, especially if you are not that experienced. To exit a long position requires selling, so this selling pressure will cause the price to fall even further. The breakouts are actually fakeouts, the price soon resumes a downward path.

Suspiciously huge bullish candlestick

To get the most out of stop loss orders, you need to get accustomed to using them every time you trade. A stop loss will always keep your losses in check, so you do not lose more than you can afford to. In a bid to get into market trends early, many traders get caught in traps and lose significant amounts of money. Unfortunately, these traps occur very often when trading cryptocurrencies. Understanding how these traps work and how to avoid them can be the key you need to enter into the right reversals.

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If the trade doesn’t work out, a stop loss order will prevent a small loss from turning into a severe one. Ethereum entered a steady decline of 29% from May 12 to May 16 .ETHUSDbegan a seemingly convincing rally , but the technicals of the chart suggest otherwise. For example, if the RSI has a hard time moving above the 50 centerline reading, this is indicative that a market shows indecision and is not yet recovering. Without momentum in the market, RSI readings will remain below 50. Try adding an indicator to the chart called “Average True Range.” Set the input parameter to “1”.

Start your crypto journey

The stock has retreated from its highs but is still barely holding an uptrend pattern. The most common way traders get trapped in these sorts of stocks is trying to short a new bout of momentum. One of the most prominent mistake short sellers make is losing sight of where the significant energy is flowing. In a stock like oanda review $JOE, it’s clear the bulls are in control, and the energy is flowing that way. Rounded tops and bottoms signal the end up of an uptrend or downtrend, respectively. A rounded top occurs when the price ascent slows down, then starts moving sideways or makes very little progress to the upside, and then starts moving lower.

Is a bull trap bullish or bearish?

A bull trap is short-term bullish but longer-term bearish. The bull trap lures in buyers, creating a short-term rise in price. This eventually gives way to selling pressure and a falling price.

While the bounce back into the pattern shows resilience, it takes a Double Top Breakout to produce a bullish P&F signal to fully counter the original Triple Bottom Breakdown. The thinkorswim platform has hundreds of technical indicators and studies to choose from, plus dozens of drawing tools so you can create your own patterns. TD Ameritrade clients have free access to articles, videos, webcasts, and a fully immersive curriculum covering all elements of technical analysis.

The best approach to manage any trades is often through risk management. If you measure the Stop Loss distance, you should multiply it by 3. Second, ingot brokers review you can find the previous resistance level and place the take-profit there . If the downward movement stays for long, it’s unlikely to continue.

However, the technical indicators on the chart illustrate how this rebound is potentially a false recovery. Price is well below trend line resistance and struggles to break above a horizontal resistance level . In addition, the recovery is not experiencing a range expansion . Lastly, the RSI indicator is unable to press above the median line at 50.

How to Avoid the Bull Trap

When I looked at the chart, it appeared to be a massive shakeout, as CHTP had one of the highest down daily volume spikes in the stock’s history. At the end of it all, I accepted the fact that the “market happened” and there is nothing I can do about it. 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. So you could be saying to yourself, well this trade worked out, but what if Zynga had tanked and you lose way more money. Now skip to day two of the trade and you will see that the stock not only gapped lower but went well below my entry point, all the way to a low of $2.85. Remember, you have likely enjoyed a positive position in the stock for some time.

Bear traps are events on the range expansion spectrum’s far-end, however, and occur at the least expected times. And because several other bears are stuck in the position as well, the stock usually continues rallying, only making their losses worse. In his own exercises with traders, he’s found the “sweet spot” to risk on any trade is roughly 1.5% of your trading account. This number can, of course vary, depending on your account size and aggression level. Bears get into bad trades every day, and not everything is a bear trap.

bull trap bear trap

Such signals can be further confirmed using other methods such as candlestick formations or indicators. For example, if, after a retest on the zone, a bullish engulfing pattern is formed, it is safe to open the buy trade. All the same, it is riskier to take buy trades at resistance level than buying at support zones. In this illustration, the ranging behavior at the resistance level as well as the huge bullish candle can be seen. Therefore, it qualifies as the perfect bull trap formation. A range means that the price appears to bounce back and forth within a support and resistance level.

Role of psychology in bull traps

Additionally, Dorsey incorporates lessons on how to use P&F charts with ETFs. He suggested adding a volume function to a daily stock price chart to see how recent trading compares over the past year or so. The S&P 500’s retreat from all-time highs in January 2022 suggests investors had witnessed a bull trap weeks before this article’s publication date. Three white soldiers is a bullish candlestick pattern that is used to predict the reversal of a downtrend. A bull is an investor who invests in a security expecting the price will rise.

How much does trading cost?

Today’s bull and bear traps excellent and is like a contrarian way of trading. As expected, the divergence led to a complete breakdown to USD402. In this scenario, a trader using only candlestick action to enter a trade would have fallen into a bull trap. Bear and bull traps are often preceded by significant RSI divergence. RSI, short for “relative strength indicator”, is a momentum indicator that charts the strength and weakness of an asset’s price.

When price then reverses, they hold on to their loss too long and/or add to their existing position. Bull traps often happen around previous highs where it looks as if the price is continuing the rally. Especially amateur traders often tend to enter too early around such key levels . It’s especially dangerous if price rallies for a bit in their favor ad the trapped traders feel too comfortable and too attached to their trade. Look for whether the asset is currently overbought, which could indicate a bearish reversal from the prevailing bullish trend. You could also wait before opening long position following a breakout, to see if the bullish trend continues.

Tradeciety is run by Rolf and Moritz who have over 20+ years of combined experience in Forex, stocks and crypto trading. The professionals are the ones who are aggressively buying and the amateurs are still happily selling, hoping that price turns again. People in disbelieve hold on to their trades that are suddenly turning into a loss. 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 . With dozens of products available, including the latest micro contracts, traders can access more opportunities and optimize their strategies and risk better.

He is especially interested in FinTech and writes about cryptocurrency, non-fungible tokens , and blockchain. In the last stage of the trap, a huge bullish candle usually takes up most of the immediate candlesticks to the left. When it reaches the top of a cycle, it is generally a period of consolidation as the bulls and bears battle it out for control. Bulls chase and ride the high of bull conditions, which can all be well and good until the next bear market returns. A bull trap I think that is very good because we have a tiny SL.

If you are familiar with how these stocks trade, they typically tank, and most traders regret not organizing a locate with their broker. The stock found short-term support that at least delays what many view as the inevitable plummet of such a stock. The stock rallied off the lows and closed near its opening price. If you don’t lose all of your chips, you can continue playing another day, which is the most important thing. As such, as Tesla went from a small niche company to the dominator it is today, shorts took every bearish catalyst as a reason to add more to their position. The best way to explain what a bear trap is through the story of Tesla’s stock, which is probably the best known “story stock” in the past generation.

As earlier mentioned, if you need to buy at a resistance level, wait until the price comes down to retest it then open a buy order. In fact, buying at the retest means the trade is much lower than one placed at the top of the breaking candle. Therefore, less money would be lost in case the trade became a loser. There is no fixed rule that buying at resistance-zones-turned-support is wrong. Traders know that a support zone, when broken, becomes a resistance zone.

The price moves above a prior high point in price or above a resistance level. Psychology also comes into play when those buyers realise there are no other buyers coming in after them. As selling begins, the traders who just bought may panic and sell, further driving the price down. As the number of buyers dwindles, the price may push slightly above a prior high point – the trap – only to fall sharply because sellers are becoming more dominant.

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