Bear Trap
The financial market can be quite uncertain and misleading sometimes. Even with the best analytical skills, predicting the market becomes difficult during such scenarios.
A bear trap is one of the most common market conditions that deceives traders. Even experienced traders end up making the wrong decisions due to such traps.
Dealing with bear traps can be difficult, but not with the right knowledge. Thus, in this article, we will have a detailed study of what a bear trap is and how to identify and avoid it.
What is a Bear Trap?
A bear trap is a scenario in which the price of an asset breaks the support levels. Expecting further decline, traders end up opening a sell position. However, instead of rising, the prices start falling, and traders’ decisions turn out to be wrong.
A bear trap is a common condition in forex, stock, indices, cryptocurrencies, and equities markets. Not only novice traders but even experienced traders became victims of these market traps.
A quick glance
A bear trap causes a bearish reversal. It causes a shift from a strong downtrend to an uptrend.
A bear trap indicates a bearish reversal. So, consider opening a buy position when you identify such traps.
A bear trap is a condition when indicators are advocating for price drops. But the price rises, deceiving the trader. That’s why it is called a bear trap.
- Watch Liquidity, Volatility, and Volume
- Identify Oversold Conditions
- Monitor Market Sentiments
- Observe The Activities of Major Market Players
A bear trap causes unstable market conditions and tensions amongst the traders. So, it may not be ideal, however, with right knowledge, you can even make favorable trades even in unfavorable market conditions.
How Bear Traps Work
In general technical analysis conditions, when the price of an asset breaks the support level, it indicates that sellers are in power. A breakout in downward directions suggests that prices are set to fall further.
Many traders at this stage open a sell position. And there is nothing wrong with it, as even the indicators are advocating the downward movements.
However, that’s how the financial market fools traders. Technical analysis works on probability. This means the chances of a price decline are high, but there is no guarantee. Due to a sudden shift in market conditions, prices may rise, trapping the investor, which leads to a bear trap.
What Causes Bear Traps
You must be thinking about why the market behaves in such a way. Different factors contribute to asset price movements. If you want to save yourself from such traps, knowledge of these factors is essential. Here are the elements that can cause a bear trap:
Highly Volatile Market:
High volatility is when asset prices see huge up and down swings. It can occur due to unexpected events, sudden announcements, big news, or uncertain market conditions. In such cases, even the technical analysis concepts do not work well, leading to false breakouts.
Oversold Conditions:
A trading instrument is said to be oversold when the asset price falls too much and becomes undervalued. And during such scenarios, the price unexpectedly rises to recover. So when opening a short sell, ensure the asset price has not dropped too much.
Less Liquidity:
Ideal trading conditions require ease in opening and closing trades at a favorable price. And this happens when the number of buyers is sufficient in the market.
However, when the trading volume and liquidity are low, the chances of bear traps are high. Especially when the bear numbers are low during the falling market, it suggests that the trend will not be sustained for long.
Change in Sentiments:
What a big group of people thinks about an asset plays a crucial role in trading. During the bearish market, when investment sentiments saw a shift from bearish to bullish. The prices are also expected to react in the same way.
Announcements, news releases, or a positive event for an asset may cause these sudden changes in sentiment. You can organize sentiment analysis to track the market mood.
Major Market Players' Activities:
The trading world consists of big market players such as central and commercial banks, multinational corporations, hedge funds, investment managers, and financial institutions.
These players place a number of high-volume trades on a daily basis. And their trades even have the power to change the direction of asset prices. Thus, bear traps can also occur due to the price manipulations by such participants.
How to Avoid Bear Traps
Many traders are scared of bear traps, and the fear is genuine. Such market manipulations can cause you to lose a significant amount.
However, you don’t need to worry about such traps. Here are the ways that help you avoid a bear trap:
Don’t trade on every breakout:
The biggest mistake you make as technical analyst traders is trading on every breakout. Remember, fake trading breakouts are prominent in the market. So, retesting and confirming breakouts before trading them.
Watch broader market aspects:
When you see everyone placing a bearish trade, it is common that you also place a trade in the same direction. However, that’s the reason why many traders became victims of market traps. Blindly following the trend without testing its effectiveness is not at all a good idea.
Use technical Analysis Indicators:
Traders struggle to identify bear traps when relying on one indicator. However, you should use at least two to four indicators to analyze a market. This will provide a clearer picture of the market.
Indicators such as RSI, Bollinger Bands, and Moving averages will help you identify the oversold conditions. So, use indicators in combinations to determine misleading market conditions.
Consider Hedging:
Hedging refers to opening an opposite position to offset the losses. If you have placed a trade during a bear trap and feel that the market is moving against you, consider hedging.
Always use Stop Loss:
Stop loss is a tool to close a position when the market moves against you. Ensure you always set a stop loss level based on your risk. So, even during bear trap trading, you will not lose much.
Final Words
Market Traps are common when trading in financial assets. It can have an adverse effect on your strategy, risk, profit, and overall psychology. Identifying bear traps is difficult even for the best traders with the best strategies.
However, you can take necessary precautions to avoid trading during such market conditions. Prepare a robust plan, organize a comprehensive market analysis, and undertake solid risk management.
Also, a good knowledge can save you from these traps. So, incorporate continuous learning for a smooth trading journey. Market Investopedia can help you in that. Get a practical understanding of market traps from our experienced team. Reach out to attend our exclusive webinars on the complex financial market conditions.
