13 July 2022 | ZebPay Trade-Desk
In trading, a bull trap is a situation where a trader buys an asset believing its price will continue to rise, only to see it fall sharply after making a new high. Bull traps occur during times of market uncertainty or when misinformation is circulating about a particular asset. It’s called a bull trap because the ignorant traders are led to believe that a falling asset is rising. This false sense of security can lead to huge losses. If a bull trap is suspected, traders should exit the trade immediately or go short. Stop-loss orders can be useful in these scenarios, especially when the market is moving quickly, to avoid getting carried away with emotions. As with many things in trading, identifying a bull trap can be difficult. However, the best way to avoid bull traps is to catch early warning signs like low-volume breakouts.
Let’s say you’re looking at a chart of an asset in a downtrend. After a while, the price reaches a point where it starts consolidating sideways in what is called a “range”. During this period, the bulls and bears are locked in a fight as they attempt to push the price in opposite directions. The bears are trying to push the price to new lows while the bulls are struggling to keep the price high. Eventually, the range breaks out as the bears win and the price drops to a new low. However, just as it looks like the downtrend is about to resume, the bulls come back and push the price back to its previous high. Many traders see this as a bullish reversal and start buying believing the downtrend is over. Unfortunately, this is usually only a temporary move and the price will soon resume its downtrend, resulting in huge losses for those who bought at or near the top.
In crypto, bull traps work quite similarly as they do in every other market. For instance, if the price of an asset has been growing progressively over the last few days, you could accept as true that it’s going to keep rising. You purchase a few and anticipate the fee to move up so that you can promote it at a profit. However, the alternative happens, and you discover yourself trapped in a dropping position. You witness the downtrend after which anticipate a bullish reversal while you may purchase the dip, questioning if you are shopping the asset at a terrific fee. The entice is famous itself as such while the fee retreats and is going lower back at the downtrend. Also noted as “useless cat bounce,” bull traps are frequently visible in crypto because of fast recoveries.
Bulls chase and ride the high of bull conditions, which may all be sensible till successive markets which are bear in nature return. Once this happens, they will get caught in an exceedingly bear lure wherever they liquidate their position at a loss. Because of a unifacial mentality (strictly bear or bull), investors aware of commerce in a securities industry might fall under the trap of shopping for high and commercialism low. Consultants counsel having a bifacial mentality to achieve each bull and bear market, as this enables bigger profits throughout semipermanent trends.
Bull lures are utilised by each-day traders and semi-permanent investors to require advantage of unsuspecting market participants. For day traders, a bull trap is a chance to short the safety because it rallies to keep a copy to the previous high. The worth can then resume its downtrend, resulting in profits for the trader. For long-term investors, a bull trap can be an opportunity to shop for security at a lower cost as it falls back on track once the rally ends. They’re then able to hold the security for a successive uptrend.
Many factors originate from a bull trap, and one among the foremost common may be a lack of shopping for volume on the rally to make a copy to the previous high. Weak buying volume is a sign that there isn’t a lot of interest within the security at a particularly low price which the bulls aren’t sturdy enough to push the worth higher. Another common reason behind bull traps is a false escape from a consolidation pattern. The worth breaks out of a variety to the upside, then again quickly falls back off and resumes its downtrend.
1. RSI Divergence
A high RSI could be an indication of a potential bull or bear trap. A Relative Strength Index (RSI) calculation can be used to identify a potential bull or bear trap. The RSI is a technical indicator that can help determine if a stock or cryptocurrency asset is overbought, underbought or both. The calculation usually covers 14 days, but can also be applied to other maturities. The point doesn’t matter in the calculation as it is eliminated in the formula. In the event of a probable bullish trap, a high RSI and overbought circumstances suggest that selling pressure is building. Traders are eager to rake in their profits and will most likely close the trade at any time. As a result, the first breakout and uptrend may not be indicative of continued price increases.
Read About: Recommendations on How to Avoid Falling Into a Bear Market Trap
2. No Increase in Momentum
When a stock with huge red candles experiences a sharp decline or gap down but then recovers very gently, it is an indication of a bull trap. Naturally, the market moves in what we know as business cycles. When it reaches the peak of a cycle, it’s usually a period of consolidation, with bulls and bears fighting for control. This lack of momentum can be interpreted as an early warning signal for an imminent market reversal.
3. No Visible Increase in Volume
If the market is truly bullish, the volume should increase noticeably as more people buy the stock as it rises. If volume increases little or not at all on the breakout, this is a sign that there is not much interest in the security at that price and the rally may not be sustainable. A price increase without a significant increase is also likely because bots and retailers compete for positions.
4. Repeated testing of resistance Levels
The first indication that a bull trap is approaching is strong bullish momentum that has been held for a long time but reacts quickly to a specific resistance zone. When a stock has established itself as a strong uptrend with little downside pressure, it means buyers are flooding all of their resources. However, when they reach a resistance level that they don’t want or fear breaking, the price usually reverses before continuing higher.
5. Absence of Trend Break
A decline in worth is indicated by a sequence of lower lows and lower highs. Trends available costs don’t continuously amend once advances are created. A downtrend remains intact as long as the increase doesn’t exceed the foremost recent lower high. Lack of confirmation is {a very|one amongst|one in every of} the most frequent mistakes made by those caught in bull traps. they ought to already suspect that if the current high does not surpass the previous high, then it’s in a downtrend or a range. This is often generally thought of as “no man’ land,” one of the worst places to start shopping for deals} unless you’ve got an honest reason to try to do so. Though some traders are also discomfited by this, most are more content expecting confirmation and buying at the next worth than trying to “get in early” and be trapped.
6. Range Formation
The final feature of a bull lure arrangement is that it creates a vary-like pattern on the resistance level. The value of AN quality is claimed to recover and forth amid a support and resistance level once it fluctuates among a range. As a result of the market possibly still making smaller, higher highs, this range might not be perfect, particularly on the higher end. Nevertheless, the beginning of the bull trap is visible, because the large candle antecedently expressed forms and closes outside of this range.
7. Dubious Big Bullish Candlestick
In the last stage of the trap, an enormous optimistic candle sometimes takes up most of the immediate candlesticks to the left. This can be typically the ultimate effort by the bulls to require management of the market before the value reverses. It may conjointly occur thanks to many different reasons:
- Huge players are deliberately pushing the price higher to lure unsuspecting consumers.
- New investors are assured that there has been a breakout and start buying again.
- Sellers intentionally let the buyers dominate the marketplace for a brief period, permitting sell limit orders on top of the resistance zone to be accepted.
Disclaimer: This report is not intended to be relied upon as advice to investors or potential investors and does not take into account the investment objectives, financial situation or needs of any investor. All investors should consider such factors in consultation with a professional advisor of their choosing when deciding if an investment is appropriate. The Company has prepared this report based on information available to it, including information derived from public sources that have not been independently verified. No representation or warranty, express or implied, is provided in relation to the fairness, accuracy, correctness, completeness or reliability of the information, opinions or conclusions expressed herein. This report is preliminary and subject to change; the Company undertakes no obligation to update or revise the reports to reflect events or circumstances that arise after the date made or to reflect the occurrence of unanticipated events. Trading & Investments in cryptocurrencies viz. Bitcoin, Bitcoin Cash, Ethereum etc. are very speculative and are subject to market risks. The analysis by Author is for informational purposes only and should not be treated as investment advice.
