What is a bear trap?
A bear trap is a false signal of the reversal of an uptrend. It is referred to as a ‘trap’ because big money investors use this strategy to lure unsuspecting traders into believing that the existing uptrend is about to reverse. The motive behind this move is to get prices to a significant low, buy the asset, and make a substantial profit selling it at a high.
What causes a bear trap?
Typically, a bear trap is set by big money traders. These investors sell the asset in large amounts. It is usually a tactic to fool gullible traders that the price’s upward trend is over. These traders will be tempted to open a short position as they expect the prices to be on a downward momentum.
Once the asset’s price gets to a significantly lower level, the trap setters will release the bear trap by buying it. Subsequently, the price will rally sharply, causing the trapped traders to exit their short positions. As they buy the asset, the buying pressure will build up and result in a further upward momentum.
How to identify a bear trap
Traders may have different approaches to identifying a bear trap in a chart. However, there are two techniques that are helpful to novice and experienced traders alike.
To begin with, the breakout candlestick has to be clearly bearish. This means that it has to breakout on the downside and close below the support level. In this technique, it is important to look at the next 1 or 2 candlesticks. These candles should illustrate a slower downward momentum. This appears in the form of a candlestick with a shorter body. It could also be a bullish reversal candle.
The other characteristic of a bear trap is that the candlestick can break past the support level on the downside. However, the prices will take an uptrend and close above the support level.
Bear trap and short selling
Traders and investors often use the bear trap for short selling. This involves selling an asset when the price is high and buying it as the price declines. This is their strategy of making significant returns from a trade.
A bear trap is a false signal of the reversal of an uptrend. To effectively trade a bear trap, traders often use technical tools such as relative strength, market volume indicators, and Fibonacci retracements. The tools help to differentiate an actual trend reversal from a bear trap.
If a steady bullish trend abruptly reverses, it is risky to act on it immediately. Instead, use several market parameters to really know what is happening. If there is no valid explanation for the change in the market sentiment and subsequent price trend, you are most likely dealing with a bear trap. For instance, as a way to identify a bear trap at its onset, market volumes signal a shift in sentiment by changing as the price hits a new low or high. However, if the asset’s price declines without a notable increase in the market volume, that is most likely a bear trap.
