Bull market traps and bear market traps are a form of washing mode, which describe the sudden change of direction of a token in a volatile market. If the trader is not careful, these are unexpected trends that may cause huge losses to the trader. Knowing more about bull market traps and bear market traps allows you to take more appropriate risk mitigation measures when investing.
What is a bull trap?
A bull trap is a false signal that assets such as tokens or cryptocurrencies are bullish, which means that prices are expected to rise.
At the beginning of the bull trap, the asset broke its resistance position and appeared to be in an uptrend. Traders expect that the uptrend will continue and the highs will get higher and higher. This will attract them to enter the market.
However, this upward trend suddenly reversed. As the price of tokens or cryptocurrencies drops rapidly, this will cause the traders who enter to suffer losses. Traders are forced to exit the trade at a loss or remain trapped in a long position.
The above is a real example of a bull trap in the Honeywell (HON) token market. The token price seems to have broken through the resistance position and is in an upward trend. However, it was followed by a reversal of the sharp downward trend. Such bull market traps will cost traders a heavy price.
What is a bear trap?
The bear market trap is the opposite of the bull market trap. This is a false sign of a reversal from an uptrend to a downtrend.
This leads traders to open short positions, hoping to profit from falling asset prices. Or, this may cause them to sell tokens or cryptocurrency assets in order to make a profit and prevent losses. However, the asset will eventually continue its upward trend, and short positions suffer losses or opportunity costs.
Institutions that drive down prices can deliberately create bear market traps. This forces traders and investors to sell assets. Once asset prices fall, institutions and other experienced traders and investors will jump back to the market to purchase assets at discounted prices. This causes asset prices to rise due to increased demand.
Bitcoin’s bear market trap example
Ethereum’s bear market trap example
How to identify and avoid potential bull or bear market traps?
Bull market and bear market traps are inherently difficult to identify because they run counter to expectations and typical price trends.
However, through careful technical analysis and fundamental analysis of assets, traders can identify and avoid potential bull or bear market traps. Here are some technical indicators and methods you can use:
- Relative Strength Index (RSI)
One way to identify potential bull or bear market traps is to calculate the asset’s relative strength index (RSI). This technical indicator allows you to check whether a token or cryptocurrency asset is overbought, underbought, or neither.
RSI is an oscillator that measures the magnitude and speed of recent price changes.
The calculation formula of RSI is:
RSI = 100– (100 / (1 + (Average Profit at Closing/Average Loss at Closing)))
This is usually calculated within a 14-day time period, although it can also be applied to other time periods. The period does not matter in the formula because it is cancelled out in the calculation. For example, if the ABC cryptocurrency closes in 14 days with an average gain of 5% and an average loss of 10%, the RSI will be calculated as follows:
RSI = 100 – (100 / (1 +
2/5 )) = 100 – 71.4
RSI is a number between 0 and 100. Assets with an RSI of about 70 and above are considered overbought, which indicates that a bearish reversal may occur due to profit-taking. On the other hand, an RSI of 30 and below is considered oversold, which means it may rise.
A high RSI may be a warning sign of a potential bull market trap or bear market trap.
- Bull trap and high RSI
In the context of a potential bull trap, higher RSI and overbought conditions mean increasing selling pressure. Traders are seeking profit and may exit trading soon. Therefore, the initial breakout and uptrend may not indicate that the price will continue to rise. On the contrary, once these traders begin to sell assets, the price may fall.
- Bear trap and high RSI
In the context of a potential bear market trap, high RSI and overbought conditions also indicate high selling pressure. In this case, the institution may encourage the sell-off of assets by driving down prices. This is to reduce the increasing selling pressure and re-enter at a lower price to obtain a better price position. At this time, the influx of purchase demand will push prices up.
In this case, the initial downward trend does not mean that prices continue to fall, because it is a temporary decline caused by profit-taking and institutional manipulation. On the contrary, once the institution obtains the available assets, the price will rise again. Therefore, a high RSI may also indicate a potential bear market trap.
- Volume indicator
In bull and bear market traps, volume is another important indicator that needs attention.
The trading volume should be higher than average to indicate a strong upward trend or market volatility and reversal momentum and increasing pressure. Therefore, low trading volume is a warning sign of potential bull and bear market traps.
- Candle pattern
Use candle patterns to identify bull traps: bullish candle patterns, such as bullish engulfing patterns, piercing patterns, tweezers bottoms, or morning stars. These are good signals 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
Candle pattern at the bottom of the tweezers. Source: TradingwithRayner
Morningstar candle pattern data source: TradingwithRayner
The following is the use of candlestick patterns to identify bear traps:
Bearish engulfing candle pattern Source: Learnstockmarket
Evening star candle pattern Source: Timothy Sykes
Three crow candle pattern Source: WarriorTrading
Strong bearish candlestick patterns to watch out for, including bearish engulfing, evening star and three crows. These bearish signals help confirm that prices will continue to fall and are not a bear market trap.
Conversely, indecisive candles (such as the Doji candle pattern) may warn of bull or bear traps. This is because the Doji candle pattern represents tension and indecision between buyers and sellers, which causes the opening and closing prices to be the same.
As always, carefully study these candle patterns in the context of broader market trends. These candle patterns should not be relied on in isolation to determine whether the upward trend continues or reverses. Having a strong foundation of technical analysis will enable you to understand the meaning of these candle patterns in the context of the market and effectively trade.
How to trade bull market traps or bear market traps?
If you are not sure whether your transaction 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 trading volume, bullish candlestick patterns, and low or neutral RSI, as described above.
Secondly, it is recommended that you set a stop loss order to minimize losses.
How to trade bull traps?
You can consider setting up a special type of stop loss order to reduce the risk of bull market traps, namely trailing stop loss orders. This is a type of stop loss that automatically follows your position when the market rises, but stays the same when the market falls.
Source of trailing stop loss order: PatternsWizard
The way it works is that you place a trailing stop loss order at a certain percentage or number of points away from the current market price. This is called trailing stop loss.
If the market price rises, the trailing stop loss order will move with the market price, lagging behind the set distance or number of points. However, in the event of a fall in market prices, it will remain unchanged. When the market price is lower than the static stop price level, your position will be closed. In this way, trailing stop loss orders can help you ensure any profit from an uptrend in trading, while minimizing your losses in the event of a bull trap or bearish reversal.
Or, you can choose to trade bull traps intentionally and profit from falling prices. For example, once the bull trap takes effect, you can open a short position directly or using financial derivatives (such as contracts for difference (CFD)).
But please note that going short is extremely risky. If your forecast is inaccurate and the market reverses into an upward trend again, you may face unlimited losses, depending on the magnitude of the price increase. This is an advanced trading measure that only experienced traders should try.
How to trade bear traps?
You can enter the market when the market is falling. However, it may be difficult to accurately determine your entry time. This may be most effective if you think there will be a short-term squeeze or believe in holding assets for a long time. For example, if you believe that cryptocurrencies will rise in the long term, then you may be more confident to buy the asset during the fall.
There are no hard and fast rules when trading bull or bear market traps. They are essentially unpredictable market movements. However, by studying relevant technical indicators and gaining more experience in the market, you will become better at identifying bull and bear market traps and trading accordingly.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/a-detailed-explanation-of-the-bull-market-trap-and-bear-market-trap/
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