Updated July 24, 2023
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 increase. 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 upward, after which the resistance level is reached, the 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 persist in selling short-limit orders when their triggers are hit, despite the price repeatedly hitting their stop-loss orders.
- When liquidity erodes at these levels, the market price declines and is within the resistance zone.
- Traders place short positions, and breakout traders jump in to recover their losses before rejoining the trend after getting stopped.
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 Does Bull Trap work?
- A bull trap chart pattern is an indication of a bearish signal.
- We will observe strong momentum-breaking resistance.
- A trader will Lookout to short the break of the bearish candlestick
- A good stop location will be when high breaks out, which indicates the Failure of a bull trap.
- As another bear candlestick appears and Trader may get stopped. It is still holding as this might come from a higher time frame.
- Keep price action 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, the 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 disbelief continue holding on to their positions, suddenly becoming lost. 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. The acceleration of the rally is a result of buying activity as most traders are compelled to exit their long trades.
A bull trap is not just a pattern; it helps explain 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 must remember not to sell when the price moves 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 goes up.
- Following a Moving Average Pattern: One of the easiest ways to explain how insurance works are by applying a moving average to charts and patterns and trading in the directional pattern, which means that he needs to trade short once the price has broken the moving average to the downside which occurs after a bull trap and enters a long trade after the 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 the opposite of a bull trap pattern, wherein price movement encourages traders to place short positions after a short consolidation period. Following this, the 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 must be careful to identify a major trend change in the market.
- It is one of the least well-known strategies among traders.
- Bull trap traders should look for two critical things to have in place: A 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 to successfully trade on the bull trap, which means he needs to miss some profitable trades.
- A bull trap is an excellent way to realize profits quickly and avoid keeping an open position for a long time.
- Sometimes, the price can continuously move in the breakout direction, so a trader needs to be prepared for a reversal.
Conclusion
A Bull Trap occurs when a trader with a 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 Trap:
- Stop chasing parabolic breakouts.
- Trade breakouts with a build-up.
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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 trap. You may also look at the following articles to learn more –
