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Bear Trap

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What Is A Bear Trap? 

A bear trap is a false signal that fools traders into opening a short position on a financial asset, thinking that the price would fall, only for the price to reverse and go upward.

Deeper Definition

A bear trap occurs when the value of a stock, cryptocurrency, or other financial assets that traders expect to make a downward movement suddenly reverses to an upward move. A bear trap is a false trend reversal signal because it occurs right after a financial asset has been in an uptrend. When the asset’s price starts falling, some traders believe the previous uptrend is over. However, the asset’s price soon goes back up again, signaling that the uptrend is not yet over.

Institutional traders often “set” the bear trap to fool other traders into thinking that an uptrend is over. They do this by continuously selling their holdings, causing the asset’s price to drop. Some notice investors seeing that price is falling, would sell their holdings too, thinking that the price would drop further. However, the institutional traders soon jump back into the market and buy more assets at a lower price, causing the prices to rise again.

Bear traps are notoriously deceptive signals that can cause severe losses to traders regardless of the kind of market. Often, it tempts traders into entering short positions, hoping to profit from the declining prices. However, when the price reverses to an upward movement, such traders get caught in the trap. To exit a short position, traders must go long, which causes the price to rise even further.

Bear Trap Example

The price of a cryptocurrency, Ethereum, has been on an uptrend for a couple of days. Since no cryptocurrency goes up in a straight line, traders expect the uptrend to come to an end at some point, but nobody knows for sure when that would happen. Shortly, Ethereum’s price started falling, causing some traders to believe that the uptrend was finally over. They enter a short position to profit from the declining prices. However, the price quickly reverses and continues its upward movement, causing those traders who went short to get liquidated.

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