What Is a Bull Trap and a Bear Trap?
These are key terminologies derived from the stock market industry which can also be applied in cryptocurrency trading. Whether traders are professional or inexperienced, these events are common and could potentially cost a lot if neither one is careful.
WHAT IS A BULL TRAP
A Bull Trap occurs when there is a quick price increase in a downtrend.
The false signal will show the asset’s (cryptoccureny or index) downtrend reversing its direction in expectation that trend will meet or breakout above the resistance level. During its sudden incline trend, investors or traders would often be lured to buy or open long on the asset, anticipating for the breakout. However, the trend reverses again after a short period of time and exposes that the value of the cryptocurrency/index is continuing to decline. Unfortunately for the bullish traders and investors, they are trapped in the trade and experience losses as a result.
WHAT IS A BEAR TRAP
A Bear Trap occurs when there is a quick price decrease in an uptrend.
The false signal will show the asset’s (cryptoccureny or index) uptrend reversing its direction towards a downtrend. This entices traders to want to quickly close their positions to avoid further loses. Some would quickly open short positions in hope that they would make profit from the decline in value, when in fact the trend suddenly reverses again and continues to incline.
CAUSES OF BULL TRAPS OR BEAR TRAPS
According to Perfect Trend System, there is no specific and clear evidence that claims a certain action in the market could result in bull and bear traps. What we can evidently pick up from is that there is a pattern in when these events occur. For example, bull trap is commonly expected near the tip of an uptrend while the bear trap is near the bottom of the downtrend.
Perfect Trend System has also noted that the rapid price action could be affected by the traps themselves. The influence they have on people’s market actions and behaviors could build further momentum for future bull and bear traps to occur again.
6 WAYS TO AVOID BULL TRAPS AND BEAR TRAPS
Whether you are a professional or a new trader, you can practice the following habits to avoid falling into the bull or bear traps.
- Check the Volume
If there is a change in the asset value but the volume remains consistent, then there is a possibility that a trap is occurring.
- Look for RSI divergence
RSI (Relative Strength Indicator) ranges between 0 to 100 and it’s a momentum indicator that charts the strength and weakness of an asset’s price. RSI <25 indicates oversold conditions while RSI >75 indicates overbought conditions. As price moves up, RSI increases if there is momentum and support behind the price increase. Similarly, RSI typically decreases when price moves downward.
Divergence occurs when price and RSI move in opposite directions. This suggests that the price movement is weak and not backed by significant momentum.
In the BitOrb Testnet’s TradingView chart, users can track the RSI and visualize the pattern against the asset price.
Source: Tradingview Chart with RSI (www.testnet.bitorb.com)
In the BitOrb exchange, traders can place orders based on the RSI indicators. You can create conditional orders using the Orchestrator for when you feel RSI becomes oversold and automatically open long positions.
Source: The Orchestrator (www.testnet.bitorb.com)
- Check the news
The news plays a significant role in the sentiments of the market towards an asset. If there is a sudden price movement with average volume, traders can check the news to be sure of making any trading actions.
- Use stop-loss orders
Even though you did your research, you can never be completely confident of your trade decision because the market could go against you. Hence, you can use a stop-loss to limit the loss allowance and hedge your position.
- Trade only in the direction of the main trend
Trading against the main trend requires a higher level of expertise and understanding of trading the respective markets. This depends on the risk appetite of the trader whether they are willing to trade against the market trend and newer traders are typically advised to follow the basic trends.
- Check the next few candlesticks after breakout
Even though a breakout occurs, traders can always check the candlesticks following the breakout to see whether it’s going to be a continuing trend or just a one-off event.
At the end of the day, even if you do fall into the bear or bull traps, don’t panic and trust what you have learned. Carry forward your new knowledge and try to not be the weak hands next time 😉