A bull trap in trading occurs while the market is in an uptrend.
The pattern is tricky because it could provide “confirmation” of a break in the resistance stage. This leads some traders who follow market action to think that the bull run is continuing and they buy trades. However, a few candles later, the price takes a sharp and vicious U-turn, signaling the start of a bearish trend. Stop losses are removed for those that have them, while the others are left holding losing trades.
What Happens in a Bull Trap?
After a long bullish trend, a bull trap is most likely to appear. This is a market movement that has been going up for some time. It indicates that the sellers have had leverage for a long time and are about to spend their resources. Once the price finally reaches a resistance region, this statement becomes true.
As shorter candlesticks shape, the price normally slows down. This phenomenon can be attributed to many long traders (buyers) taking gains at the resistance stage. After that, the demand begins to stall until further sellers enter and attempt to drive the price beyond the resistance zone. A breakout is formed as a result of this. Unwary customers see this as a continuation of the uptrend and place further buy orders.
As a result of the imbalance between retreating buyers and competitive sellers, the pattern favors the sellers. If the trend continues to decline, new buyers’ stop losses are removed, putting sellers in a better position.
Stop losses have at this stage been activated by consumers who believed the trend would continue to rise. Many with wider stops, or those that don’t have any, are stuck in a pattern that is working against them now.
Identifying and Avoiding a Bull Trap
A bull trap can be identified and avoided in a variety of ways. We’ll go into a few of the most useful approaches below.
Trading volume is a crucial distinction between a bull trap and a clear upside breakout. When you see a breakout on low volume, it’s a bull trap. Low volume normally happens when liquidity is limited, implying that there aren’t enough buyers to consume the breakout until liquidity improves.
Dojis or spinning tops are other significant indicators of a bull trap. When an indecisive candlestick pattern appears shortly after an upside breakout, fight the urge to open a long spot. Strong upside moves and high market volume are normally seen after a valid breakout. If the stock develops a powerful bullish candlestick shortly after the breakout, the breakout could be genuine, and the market may begin to rise.
You don’t have to launch a long position right away after an upside breakout. Rather, check for a pullback to confirm the breakout. When the stock rolls back and faces demand pressure right at the broken resistance stage, a pullback occurs, indicating that new entrants enter the market and drive the price upwards. If the pullback struggles to gain help at the recently breached resistance stage, we may be in the midst of a bull trap.
Several Retests of a Resistance Level
Bull traps can also be predicted by looking at market history. When a high resistance level is repeatedly retested, sellers lack the strength to lift the price past the resistance level. To put it another way, any push above resistance should be treated with caution because it might lead to a bull trap.
Experienced traders pay heed to cross-market correlations in addition to technical thresholds, which may assist them in escaping bull traps. Correlations between dependent commodities, such as interest rates and shares, gold and the US currency, or commodity currencies, are known as cross-market correlations.
It’s not enough to accurately identify demand direction; you still need a decent entry point. If an upside breakout turns out to be a bull trap, late entrants raise the risk of losing money. For all costs, avoid late entries because you’ll get another trading chance.
Bull trap trends have a reputation for luring traders into taking high-risk bets that nearly inevitably lead to losses. Bull traps may prove to be lucrative if you grasp how they grow and what they represent.