What is a bull trap in trading – all you need to know
A bullish or also called bull trap, represents a false signal, indicating a downtrend in crypto, stock, index, or other security that reverses after a stable rally and breaks a previous support level.
The move traps traders and investors who react to the buy signals and lead to losses on the resulting long position. A bull trap can represent a whipsaw pattern.
The bear trap is the opposite of a bull trap, which occurs when sellers fail to press a dip below a breakdown level.
Bull trap – what does it mean
A bullish trap occurs when an investor purchases security that breaks above a resistance level – a common strategy based on technical analysis.
These breakouts are known as “bull traps” because traders and investors who purchased the breakout are trapped in their trade. While some breakouts are followed by strong upside moves, the security can quickly change direction.
Traders and investors can avoid upside traps by looking for confirmations after a breakout. For instance, a trader might look for above-average volume and a bullish candle after a breakout to confirm that the prices are likely to rise.
Breakouts that generate low volume and undecided candlesticks – like a Doji star candlestick – could be an indication of a bull trap.
From a psychological perspective, a bull trap candlestick pattern takes place when bulls fail to sustain a rally above breakout levels. The reason for this could be a lack of momentum or grip on profits.
Bears may take the chance to sell the security if they notice divergences, causing prices to fall below the resistance level, which can trigger a stop loss order.
The most convenient way to handle a bull trap is to notice warning signs, such as low volume breakouts, in advance and leave the trade in no time if you suspect a bull trap. A stop loss order can be useful in these circumstances, particularly if the market is moving fast, to avoid letting emotion lead to decision-making.
Key points to remember
A bullish trap indicates a reversal that forces market participants to exit a position with unexpected losses on the wrong side of the price action.
Upside traps occur when buyers fail to sustain a rally above a breakout level.
Traders and investors can reduce the frequency of bullish traps by looking for confirmation following a breakout by technical indicators and pattern divergences.
Bull Trap Example
Let’s suppose that the stock sells off and reaches a new 52-week low prior to bouncing sharply off the high volume and back up into trendline resistance. Some traders and investors jump in on the move, predicting a break of trendline resistance.
But the stock reverses at resistance and goes significantly lower from those levels. New bulls are now trapped in a long trade and suffer quick loss unless an aggressive risk management strategy takes place.
The trader could have avoided the bullish trap by waiting for a breakout to unfold before buying the stock or at least mitigating the losses by setting a tight stop-loss below the breakout level.