What Is A Bull Trap?
A bull trap is a false signal that fools investors into thinking that a declining asset is reversing and now going upward, only to repeat its downward trend.
A bull trap occurs when the value of a stock, cryptocurrency or other financial asset reverses after a downtrend, breaks a prior support level, and appears to be going up, making traders or investors believe that the security will sustain the upward movement. Instead, the upward movement quickly comes to an end, and the security resumes its downward trend, declining even further.
Bull traps are notoriously deceptive signals that can cause severe losses to traders and investors regardless of the kind of market, hence why it is known as a “trap.” Ideally, a strong uptrend follows a breakout after a downtrend. However, a bull trap fools traders to open new long positions or purchase more of the asset, thinking that an uptrend would follow as with a regular breakout. Instead, a sharp decline occurs, “trapping” them in the trade.
By taking certain precautions, such as looking for additional confirmation signals following a breakout, traders and investors avoid bull traps. For instance, a breakout that is not backed with high trading volume could mean a bull trap is waiting to happen. Also, an indecisive candlestick, such as a Doji star, could signal an upcoming bull trap.
Though technical indicators can help you avoid falling into a bull trap, you must remember that technical indicators do not guarantee that a price will move a certain way. With technical indicators, usually, you cannot be 100% certain that the upward movement won’t hold or that a bull trap will occur. That is why it is advisable always to employ a stop-loss order when entering a trade. A Stop-loss order allows traders to specify a price at which to sell the asset if the price moves downward instead of the expected upward movement.
Bull Trap Example
The price of bitcoin started declining during the weekend. On Tuesday morning, some traders noticed that the price of Bitcoin was beginning to go up again. Not wanting to miss out on the profits they will make if they take a long position early, some traders entered the trade without waiting for further confirmation. Shortly after, Bitcoin sharply reverses from the temporary upward movement and returns to the downtrend, trapping those traders who entered long positions.« Back to Glossary Index