Bear and bull traps

Markets are constantly in motion, and charts often change trend directions. These changes usually follow the same pattern, but sometimes the charts contain traps that can lead to poor investment decisions and loss of money.

Bear traps and bull traps are situations in which the market gives the false impression that asset prices will move in a certain direction, only to abruptly change direction.

Bull traps can occur for various reasons, ranging from trivial market manipulation and news to traders' emotional reactions to multiple events.

Surely many people have seen charts with a prolonged price rise. It is logical to assume that such assets cannot grow forever, and traders who want to successfully open a short position can get caught in a sharp downward movement.

Bear trap

A bear trap is a situation where the market gives the appearance that prices will go down but then quickly recover. At this point, traders who have opened a short position start to lose their money as the rate has gone against them.

One of the most striking examples of a bear trap is Tesla stock. Many traders and funds were skeptical about the company's long-term success, so they sought the best time to short the stock. However, as time has shown, all short-term declines on the chart were bear traps.

Bull trap

On the contrary, a bull trap occurs when the market gives the appearance of the beginning of a price rise, but then the chart turns sharply downward. These traps usually happen during market uncertainty or when false information about a particular asset is spread.

Traders and investors are instilled with false optimism, which can lead to significant losses. When it seems that the downtrend is about to end and the upward trend is about to begin. Then, many traders mistakenly see a bullish reversal on the chart and start buying, thinking that the fall has already stopped.

Unfortunately, this is often only a temporary movement, and the price soon resumes its downtrend, leading to big losses.

Traps — what to do?

Avoiding bear and bull traps in trading can be difficult, but it is possible.

First, evaluate the trading volume before you mistake a spike for a reversal. If, on a breakdown of a support or resistance level, volume is unchanged or even lower than when trading during the previous trend formation, this is a sure sign of a trap.

Secondly, checking the current RSI level also helps identify traps. If the values are close to the indicator's boundaries, it can also be a sign of a potential bullish or bearish trap.

However, performing technical analysis and keeping an eye on the fundamental aspects of the market and the asset is essential. The absence of positive news could cause a sharp rise in quotes, which indicates the preparation and triggering of a bull trap.

Similarly, if the news does not contain outright negativity that could trigger a rapid price drop, the downward momentum likely indicates the preparation of a bear trap.

Despite the above-mentioned methods, there is no reliable way to recognize a trap in advance, so it is very important to have a clear exit strategy — set stop-loss orders and stick to a predetermined plan.