One article explains bull market traps and bear market traps, no longer afraid of market ups and downs

Bull and bear traps are a form of whipsaw patterns that describe movements where coins suddenly change direction in a volatile market. These are unexpected movements that can lead to huge losses for traders if they are not careful. Knowing more about bull and bear traps can allow you to take more appropriate risk mitigation measures when investing.

What is a bull trap?

A bull trap is a false signal that an asset such as a coin or cryptocurrency is bullish, meaning that the price is expected to rise.

At the beginning of a bull trap, an asset breaks out of its resistance level and appears to be in an uptrend. Traders expect the uptrend to continue and make higher highs. This attracts them to enter the market.

However, this upward trend suddenly reverses. This results in losses for the traders who entered as the price of the coin or cryptocurrency drops rapidly. Traders are forced to exit the trade at a loss or remain trapped in their long positions.

Above is a real example of a bull trap in the Honeywell (HON) token market. The token price seemed to have broken through the resistance level and was in an uptrend. However, it was followed by a sharp downtrend reversal. Such a bull trap can cost traders dearly.

What is a bear trap?

A bear trap is the opposite of a bull trap. It is a false sign of a reversal from an uptrend to a downtrend.

This causes traders to open short positions, expecting to profit from a drop in the price of the asset. Alternatively, it may cause them to sell the token or crypto asset in order to take a profit and prevent losses. However, the asset eventually continues its upward trend, and the shorts incur losses or opportunity costs.

Institutions that drive prices down can intentionally create bear traps. This forces traders and investors to sell the asset. Once the price of the asset drops, institutions and other experienced traders and investors jump back into the market to buy the asset at a discount. This causes the price of the asset to rise due to increased demand.

Bitcoin Bear Trap Example

Ethereum’s Bear Trap Example

How to identify and avoid potential bull or bear market traps?

Bull and bear traps are inherently difficult to identify because they go against expected and typical price trends.

However, by performing careful technical and fundamental analysis of an asset, traders can identify and avoid potential bull or bear traps. Here are some technical indicators and methods you can use:

• Relative Strength Index (RSI)

One way to identify potential bull or bear traps is to calculate an asset’s Relative Strength Index (RSI). This technical indicator allows you to check if a coin or crypto asset is overbought, underbought, or neither.

The RSI is an oscillator that measures the magnitude and speed of recent price changes.

The calculation formula for RSI is:

RSI = 100– (100 / (1 + (Average Gain at Close / Average Loss at Close)))

This is usually calculated over a 14-day period, although it can be applied to other time periods as well. The period does not matter in the formula as it is canceled out in the calculation. For example, if the ABC cryptocurrency closed with an average gain of 5% and an average loss of 10% over a 14-day period, the RSI would be calculated as follows:

RSI = 100 – (100 / (1 + 2 / 5))
= 100 – 71.4
= 28.6

The RSI is a number between 0 and 100. An asset with an RSI of about 70 and above is considered overbought, which indicates a possible bearish reversal due to profit-taking. On the other hand, an RSI of 30 and below is considered oversold, which means it could potentially rise.

A high RSI can be a warning sign of a potential bull trap or bear trap.

• Bull Traps and High RSI

In the case of a potential bull trap, a higher RSI and overbought conditions mean that selling pressure is increasing. Traders are looking to take profits and may exit their trades quickly. Therefore, the initial breakout and uptrend may not indicate a sustained increase in prices. Instead, prices may decline once these traders start selling the asset.

• Bear Traps and High RSI

In the case of a potential bear trap, high RSI and overbought conditions also indicate high selling pressure. In this case, institutions may encourage selling of the asset by pushing the price down. This is to reduce the increasing selling pressure and re-enter at a lower price to get a better price position. The influx of buying demand at this time will drive the price back up.

In this case, the initial downtrend does not indicate a sustained price drop, as it is a temporary drop caused by profit-taking and institutional manipulation. On the contrary, once institutions get their hands on available assets, prices will rise again. Therefore, a high RSI may also indicate a potential bear trap.

• Volume Indicators

Volume is another important indicator to watch out for during bull and bear traps.

Volume should be above average to indicate a strong uptrend or momentum and increasing pressure for market swings and reversals. Therefore, low volume is a warning sign of potential bull and bear traps.

• Candlestick Patterns

Identify bull traps using candlestick patterns: Bullish candlestick patterns such as the bullish engulfing pattern, piercing pattern, tweezer bottom or morning star. These are good signs that the market is indeed in an uptrend and it is not a bull trap.

Bullish engulfing candle pattern Source: TradingwithRayner

Piercing candle pattern Source: TradingwithRayner

Tweezer bottom candle pattern Source: TradingwithRayner

Morning Star candle pattern Source: TradingwithRayner

Here are some ways to identify a bear trap using candlestick patterns:

Bearish engulfing candle pattern Source: Learnstockmarket

Evening Star candlestick pattern Source: Timothy Sykes

Three Crows Candlestick Pattern Source: WarriorTrading

Strongly bearish candlestick patterns to watch out for include the Bearish Engulfing, the Evening Star, and the Three Crows. These bearish signals help confirm that prices will continue to fall, rather than being a bear trap.

Conversely, indecisive candles, such as the Doji candle pattern, may warn of a bull or bear trap. This is because the Doji candle pattern indicates tension and indecision between buyers and sellers, which results in the same opening and closing prices.

As always, these candlestick patterns should be carefully studied in the context of the broader market trend. These candlestick patterns should not be relied upon in isolation to determine whether an uptrend will continue or reverse. Having a strong technical analysis foundation will allow you to understand the meaning of these candlestick patterns in the context of the market and trade them effectively.

How to trade a bull trap or a bear trap?

If you are unsure whether a trade you are taking is a bull trap, you can choose to be more cautious and set up appropriate risk management measures.

First, you can look for signs of confirmation, such as higher volume, bullish candlestick patterns, and a low or neutral RSI, as mentioned above.

Secondly, it is recommended that you set a stop-loss order to minimize losses.

How to trade the bull trap?

You can consider placing a special type of stop order to reduce the risk of a bull trap: a trailing stop order. This is a type of stop loss that automatically follows your position when the market is rising, but remains in place when the market is falling.

Trailing Stop Order Source: PatternsWizard

The way it works is that you place a trailing stop order a certain percentage or pips away from the current market price. This is called a trailing stop.

If the market price is rising, the trailing stop order will move with the market price, trailing the set distance or number of pips. However, in the case of falling market prices, it will remain static. When the market price drops below this static stop price level, your position will be closed. In this way, a trailing stop order can help you secure any profits you make from trading an uptrend, while minimizing your losses in the event of a bull trap or bearish reversal.

Alternatively, you can choose to intentionally trade a bull trap and profit from the price drop. For example, once a bull trap takes effect, you can open a short position directly or using financial derivatives such as contracts for difference (CFDs).

However, please note that shorting carries an extremely high risk. If your prediction is not accurate and the market reverses to an uptrend again, you could face unlimited losses, depending on how far the price rises. This is an advanced trading move that only experienced traders should attempt.

How to trade bear traps?

You can enter a trade when the market is falling. However, it can be difficult to time your entry accurately. This may work best if you think there will be a short squeeze or believe in holding the asset for the long term. For example, if you believe a cryptocurrency will rise in the long term, you may be more confident buying the asset during a dip.

Summarize

There are no hard and fast rules when it comes to trading bull or bear traps, they are inherently unpredictable market movements. However, by studying relevant technical indicators and gaining more experience in the markets, you will become increasingly adept at identifying bull and bear traps and trading accordingly.