What is a Bull Trap in Trading and How to Avoid It IG International

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A bull trap, in the context of trading, occurs when there is a false signal indicating the start of a bullish trend. It tricks investors into believing that an asset’s value is about to rise, prompting them to buy at seemingly opportune moments. However, the upward movement is short-lived, and the asset’s price soon reverses, resulting in sudden losses for those who fell for the trap. In the fast-paced world of financial trading, understanding the various market phenomena can make all the difference between success and failure.

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However, the trap pattern presents itself under varying market conditions that we can’t give a specific statistic. This sharp move masquerades itself as a zone breakout, inviting buyers to join the move quickly. You might find it challenging to wrap your head around why such a regulated industry as this traps traders like us. https://cryptolisting.org/ If you have been trading for a while, you’d have fallen prey to these traps repeatedly, and knowing much more about them is critical to your investment career. The best way to escape a bull trap is set a stop-loss on your position as you open it. This will help you to prevent heavy losses if you’re caught out by a bull trap.

Resistance level being tested multiple times

The best way to handle bull traps is to recognize warning signs ahead of time, such as low volume breakouts, and exit the trade as quickly as possible if a bull trap is suspected. Stop-loss orders can be helpful in these circumstances, especially if the market is moving quickly, to avoid letting emotion drive decision-making. Traders and investors can avoid bull traps by looking for confirmations following a breakout. For example, a trader may look for higher than average volume and bullish candlesticks following a breakout to confirm that price is likely to move higher.

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Normally, we might expect this breakout to result in a series of higher highs as the level of resistance has been breached. But, in this particular example, the breakout was actually a bear trap. If a trader had opened a long position shortly after the breakout, they would’ve quickly found themselves confronted by a bearish reversal against the prevailing trend. A bull trap is a reversal against a bullish trend that forces long traders to abandon their positions in the face of rising losses. It is called a trap because it often catches traders off-guard, and comes on the back of a strong market rally that looked likely to continue.

1. Once a reversal is confirmed, you may still enter a trade and benefit from the downward price movement.
2. There is no fixed rule that buying at resistance-zones-turned-support is wrong.
3. A bull trap is when a security falling in price suddenly reverses direction and sees a momentary price increase.
4. All traders have memories of trades that appeared very obvious to them, but, once they were in, the trades turned against them and ended as losers.

Bull traps are particularly problematic for traders and investors heavily relying on technical analysis. Technical analysis involves examining charts and other statistical data to identify trends and patterns that may indicate the direction of a stock or other financial instrument. By using technical analysis tools, such as trend lines and moving averages, you can better understand whether a stock is truly trending upward or if it may be headed for a bull trap. Using this as your indicator, the bulls might buy to maintain an upward trend, trying to break above $25k. However, as they get closer to this level, they could lack momentum, leading to a bull trap. The reason bull traps are tough for new investors is the emotional aspect of the trade.

#4 RSI Indicates Overbought

However, when the supposed upward trend quickly reverses, they are left with depreciated assets. Selling these assets to cut losses culminates in a losing trade, a direct financial blow to the investor. The principal risk of a bull trap is the potential financial loss. Investors, deceived into believing that the market trend is bullish, often invest heavily. Indicators like moving averages, relative strength index (RSI), and Bollinger Bands, among others, can help identify market conditions that often precede bull traps. A bull trap can also occur when investors become overly optimistic about the prospects of a particular asset or market.

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On the other hand,  bull traps can provide successful setups if you understand how they form and what they mean. Bull traps are characterised by low trading volume and divergence between the price and momentum indicators, such as MACD and RSI. We’ve shown how bull traps may be recognised and even traded profitably while minimising risks and maximising rewards. A bull trap occurs when a trader or investor buys a security that breaks out above a resistance level—a common technical analysis-based strategy. While many breakouts are followed by strong moves higher, the security may quickly reverse direction.

The stock also double-topped at the high of the day around $3.80. That’s another sign the stock couldn’t follow through with its upward momentum. The multiple big red candles following the failed breakout are a good example of why you should never hold and hope. A failed breakout — or a fakeout breakout as I like to call it — is another bull trap. You think you see a perfect buy signal, like a stock breaking out or bouncing, so you buy. Then the stock quickly reverses and heads in the other direction.

To not fall into bull traps, you must pay close attention and comprehend how markets work. When a stock’s price surpasses an important resistance level, traders need to be careful and consider other elements that confirm its truthfulness. Bull traps in the financial market are deceptive signals that lead to significant losses as the asset’s price declines after an initial rise. They are characterized by sudden price increases without supporting news, decreased trading volume, and failure to surpass previous highs. Understanding both bull and bear traps can significantly improve trading strategies.

The available research on day trading suggests that most active traders lose money. CMC Markets Canada Inc. is a member of the Canadian Investment Regulatory Organization (CIRO) and a member of the Canadian Investor Protection Fund. CFDs are distributed in Canada by CMC Markets Canada Inc. acting as principal.

The psychology of bull traps is mainly driven by fear and greed. In my years of trading, I’ve found that resistance levels are more than just lines on a chart. They represent psychological barriers that can have a significant impact on price action.

A bull trap is an upward price movement that resembles a reversal from a downward trend. Often, bull traps involve an upward bounce off a support level or an upward break through a resistance level. These setups can trick bullish traders into buying a stock on the belief that a sustained upward price movement is just beginning.

Many traders saw this uptick as a signal that the bearish trend was over, and it was a good time to invest. Unfortunately, this surge was short-lived, and the price soon plummeted again, eventually dropping to below $30,000 once more. In this article, we’ll be detailing the inverse version of the well-known head and shoulders chart pattern so you can start effectively incorporating it into your trading. An inverse head and shoulders pattern is a technical analysis pattern that signals a potential… ● The trader then placed the stop loss below the support zone and the take profit above the highest candlestick or on the next resistance level.

In the flash of an eye, all of the worries wash away from you and your confidence begins to build. Then just as quickly as you feel you are in control of the situation, you wake up to a morning gap down or if you are day trading, the stock just plummets on high volume. At the end of the day, it may be wise to avoid trying to time the market and instead buy into long-term investments or invest in more diversified securities, like mutual funds.