What Is Bear Trap? How To Profit From Bear Trap While Trading?

Traditionally, as an example, let us look at the daily EUR/USD chart. Before the uptrend, three false breakouts of the support level formed, which drove less experienced traders into a bear trap. In addition, all three false breakouts were accompanied by the formation of bullish trend reversals, such as piercing, morning star and doji.

Risks of bear traps in trading

However, this downward movement is deceptive, as prices suddenly reverse and surge upwards, trapping traders who had anticipated a continuation of the downward trend. The bear trap vs. lies in the false signals conveyed by the initial price decline. Bull traps occur when there is a temporary halt or reversal in an upward price movement in financial markets, creating the false impression that it might start declining (become bearish).

Bear trap vs bull trap

Bear traps can be identified by observing sudden price drops, short selling activity, and subsequent price reversals. There may be a short period of time during this downtrend where the price stabilises or shows a slight upward movement. Traps can be deceptive moves designed to take advantage of traders and investors by preying on their emotions and exploiting expectations and hopes.

False Signal

If the shares fall to $80, you can close your short position and profit by $20. However, if the market rises to $110 and resumes its upward trend, closing your short position will result in a $40 loss. To avoid falling prey to bear traps, use risk management techniques, exercise patience, and utilize technical indicators, market trends, and sentiment analysis.

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. You should consider whether you understand how this product works, and whether you can afford to take the high risk of losing your money. Not using stop-loss orders exposes traders to significant risks when a bear trap occurs. Setting a stop-loss order at a reasonable level above the entry point can limit losses if the market reverses unexpectedly. Bear trap takes place in an uptrend and looks like a trend reversal formation. Bears activate and post short positions, but soon buyers push harder, and the uptrend continues leaving bears without profits and even causing severe damages.

Sharp Reversal

In conclusion, understanding the mechanics of bear traps and employing effective trading strategies can help traders navigate the complex world of stock trading. By utilizing technical indicators, market trends, sentiment analysis, risk management techniques, and patience, traders can minimize potential losses and maximize profits. As the market continues to evolve, staying informed and adapting to new challenges will remain crucial for success. A bear trap unfolds when a stock or another asset witnesses a significant price drop, triggering short-selling activity. The subsequent price reversal traps bearish investors who had anticipated further price decline.

AI announced it was raising its upcoming earnings guidance before the earnings release. Short sellers were caught offside as a violent short squeeze ensued. Complacent bears were caught off guard as volume started to rise in the coming day as sharp rallied to a high of $44.02 by May 30. The bear trap trade successfully squeezed short sellers into the earnings report, which caused shares to fall back to the $30 range, but the damage was done as illustrated on the bear trap chart.

These reactions are often exaggerated, causing sharp but unsustainable declines. In addition, traders can often overemphasize technical levels like support and resistance. A break below a key support level might be considered a bearish signal, prompting widespread short-selling. However, without confirming with other indicators, such moves can quickly reverse, trapping short sellers. It occurs when a declining trend in a security or other asset appears to reverse and head upward but then resumes its downward trend. This temporary reversal misleads traders into thinking the asset is on the path to recovery, prompting them to buy, only for the price to fall again, trapping investors in unfavorable positions.

The short selling of markets can be very dangerous because of these times. Traders need to use caution, employ effective risk management strategies, and conduct further analyses before making investment decisions based on bear and bull traps. A bear trap is usually created by institutional investors or big traders to set up retail or naive traders to take short positions.

Grasping these underlying causes aids traders in more effectively navigating these deceptive situations with increased awareness and caution. These indicators include the Fibonacci retracement tool, moving average (MA), moving average convergence/divergence (MACD), and Bollinger Bands. In investing, sentiment analysis gauges attitudes toward securities, markets, or the financial market overall. We already mentioned using best bitcoin cloud mining contracts 2020 natural language processing to analyze news articles and financial reports, but this need not be a major endeavor with sophisticated machine learning algorithms. Some quick counts of positive versus negative terminology in earnings calls and financial statements can give you a good sense of the mood. They can repurchase the funds they have sold but will have to spend more money than they have received to sell the asset.

Choosing the wrong direction can result in losing the entire trade if you hang onto it. Suppose you get caught in the bear trap while trading; close the trade and don’t let it run in the wrong direction. While there is plenty of advice and offers claiming to help you navigate bear traps, it’s essential to assess their credibility.

They can create a false sense of bearish sentiment by selling large quantities of a particular asset, which causes smaller traders to panic and start selling as well. Trading in the stock market can be a thrilling ride, filled with opportunities and risks. One of the most intriguing and deceptive phenomena traders may encounter is the bear trap.

A false breakout of the key support level encourages inexperienced traders to enter short selling positions and set stop losses higher, which subsequently leads to panic-induced exiting at a loss. This is basically large players, banks, market makers collecting liquidity, which serves as a momentum for the development of an upward trend. Other tips include paying attention to a trading volume and using stop orders.

As the prices start to grow, short sellers have to close their positions not to lose much. This moment when bears cover positions and bulls increasingly buy the asset is the switch point where bears can minimize their losses and prevent losing all in a bear trap. One of the main reasons why bear traps occur is due to market manipulation by large players such as institutional investors or hedge funds.

In 2022, Bed Bath & Beyond’s fundamentals were weak, with around $3 billion of debt and little cash on its balance sheet. With its business struggling, and investors questioning whether the company could continue, traders identifed an opportunity for short selling. After a strong upward rally, the price of the asset looks to have encountered strong resistance and starts to decline. This prompts bearish traders to open short positions, hoping to profit from a further decline.

1. Divergence is the condition when the technical tool and the price action no longer show the same momentum.
2. First, they can diversify across different asset classes, sectors, and geographical regions to mitigate the effects of a bear trap.
3. On the other hand, traders who waited for the price to close outside of the trend line and make a retest would have been able to avoid the bear trap and make a profitable trade.
4. In addition, it is important to know the bearish candlestick patterns to determine the level for locking in profit.
5. Bear traps are misleading market situations in which a seeming decline in asset prices lures investors into expecting continued downtrends.

To avoid bear traps, you should pay attention to unexpected price changes that contradict the tech indicators. If the trading volume is low, the chances of an actual trend reversal are negligible. You can always protect your investment using stop orders, other candlestick patterns, tech indicators, and posting long positions when necessary.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result.

We realize that everyone was once a new trader and needs help along the way on their trading journey and that’s what we’re here for. To gain more insights into this crucial aspect of trading, delve into our Trading Psychology guide. Someone on our team will connect you with a financial professional in our network holding the correct designation https://cryptolisting.org/ and expertise. Our mission is to empower readers with the most factual and reliable financial information possible to help them make informed decisions for their individual needs. Our writing and editorial staff are a team of experts holding advanced financial designations and have written for most major financial media publications.

If the trading volume is high during a breakout it confirms the continuation of the trend. High volume means more and more traders are willing to bet on the current trend. Divergence is the condition when the technical tool and the price action no longer show the same momentum.