Definition of Bull Trap
Bull trap pattern typically occurs at a resistance level and is a bearish signal forming with an uptrend. It does not require to be on an all-time high. An investor should search for a bull trap in a bullish market where the price is expected to move in an upward direction. An investor needs to monitor markets carefully to catch a turn in a trend.
It often occurs in Futures, Stock markets, Forex and Currency pairs. Some experienced traders use the chart pattern and technical analysis to look for trapped traders and try to benefit from the scenario.
Explanation of Bull Trap Chart Pattern
- The market price is moving in an upward direction after which the resistance level is reached, price further breaks out and then it continues to move in the same direction.
- Traders reach a breakout jump places buy orders and price surge.
- Traders continue to sell limit short is triggered while the price continues hitting their stops.
- When liquidity erodes at these levels, market price declines back and is within the resistance zone.
- Traders are placed short, breakout traders jump in to recover their loss, then rejoined the trend after getting stopped out
Who are Trapped Traders?
- Traders with short positions are taken out and trapped out of the market
- Traders with the Long position are still within the market range after which the price moves in the opposite direction trapping them while they still hold the position for a bounce-back.
How to Realize Profit from Trapped Traders?
- Identify a price movement coming into Resistance
- To trap the breakout traders let the price above the resistance zone
- Entry trigger occurs when strong bearish close below the Resistance zone
How Bull Trap Works?
- A bull trap chart pattern is an indication of a bearish signal.
- A strong momentum breaking resistance will be observed.
- A trader will Lookout to short the break of the bearish candlestick
- A good stop location will be when high breaks out which indicates Failure of a bull trap.
- As another bear candlestick appears and Trader may get stopped out. The bull trap is still holding as this might be coming from a higher time frame
- Price action should be kept in mind to book profits. An uptrend is still valid until proven otherwise.
How to Trade Bull Traps (Dynamics of the Bull Trap)
- A long sell-off where traders miss profit opportunities and become greedy in search of more profits.
- Price sets up a new uptrend that attracts investors to enter new positions. In other words, price starts a new trend wave by breaking the previous lows.
- Price is slightly in favor of ‘trapped’ traders, providing them confidence and security.
- Price reversal takes place. People in disbelieve continue to hold on their positions that suddenly turns into a loss. Traders who are aggressively buying are making huge profits and the opposite party is selling, with the belief of price turning again.
- As the price rallies, trapped short traders face huge losses on their position. Most are forced out of their long trades which means that they have to buy which accelerates the rally.
Bull trap not just a pattern, but it helps in giving a better understanding as to how the average trader approaches the markets and why the professionals usually win.
How to Avoid the Bull Trap?
- Late Entry and Exit: A trader always needs to keep in mind not to sell when the price is moving up and never buy when the price is moving down. He can enter the market and short his position when the price is already going down and buy the position when the price is going up.
- Following a Moving Average Pattern: One of the easiest ways to explain as how insurance works is by applying a moving average to charts and patterns and trade in the directional pattern which means that he needs to trade short once price has broken the moving average to the downside which occurs after a bull trap and enters a long trade after price has broken the moving average to the upside which occurs after a bear trap.
Bull Trap vs Bear Trap
A bull trap pattern occurs when there is a breakout and the price has been consolidated. It is more clearly visible when traders trade based on technical analysis and chart patterns. A bear trap pattern is exactly opposite of a bull trap pattern wherein price movement encourages traders to place short positions after a small period of consolidation. Following this, price breaks out to the downside and it often signifies a correction or reversal of a trend.
Key Points to Remember:
- The risk to reward profiles can vary in either direction. an investor needs to be careful to identify a major trend change in the market.
- It is one of the least well-known strategies amongst traders.
- Bull trap trader should look for below two important things to have in place:
- Strong resistance level formed by a previous high
- Confirmation of price action of reversal like a bullish rejection candle, inside bar or engulfing pattern in a bearish market
- A trader needs to be patient enough in order to successfully trade on the bull trap which means he need to miss some profitable trades.
- A bull trap is a good way to realize profits quickly and avoids keeping an open position for a long period of time.
- A trader needs to be prepared for the reversal as sometimes price can continuously move in the direction of the breakout.
A Bull Trap occurs when a trader with buy position breakout to have the price reverse lower. A Bull Trap trading strategy involves fetching profit from trapped traders. Two ways can help in avoiding a Bull Trap:
- Stop chasing parabolic breakouts.
- Trade breakouts with a build-up.
This is a guide to Bull Trap. Here we discuss the definition and working of bull trap along with how to trade and avoid the bull trap. You may also look at the following articles to learn more –
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