Bear Trap

What Is a Bear Trap?

A bear trap is a technical pattern that happens when the price action of a stock, index, or another financial instrument erroneously flags a reversal from a descending trend to an upward trend. A technical analyst could say that institutional traders try to make bear traps as an approach to enticing retail investors to take long positions. Assuming the institutional trader is fruitful, and the price moves higher momentarily, it enables the institutional traders to dump bigger positions of stock that would some way or another push prices a lot of lower.

How a Bear Trap Works

In certain markets, there might be a lot of investors hoping to buy stocks however couple of sellers who will acknowledge their offers. In this case, the buyers could increase their bid — the price they will pay for the stock. This will probably draw in additional sellers to the market, and the market moves higher on account of the imbalance among buying and selling pressure.

Notwithstanding, when stocks are acquired, they automatically become selling pressure on that stock since investors possibly earn profits when they sell. Consequently, assuming too many individuals buy the stock, it will decrease the buying pressure and increase the potential selling pressure.

To increase demand and get stock prices to rise, institutions could push prices lower so the markets look bearish. This makes fledgling investors sell stock. When the stock drops, investors bounce once more into the market, and the stock prices rise with the increase in demand.

Special Considerations

A bear trap can provoke a market participant to expect a decline in the value of a financial instrument, inciting the execution of a short position on the asset. Be that as it may, the value of the asset remains flat or rallies in this scenario, and the participant is forced to cause a loss.

A bullish trader might sell a declining asset to hold profits while a bearish trader might endeavor to short that asset to buy it back after the price has dropped to a certain level. On the off chance that that descending trend never happens or inverts after a short period, the price reversal is recognized as a bear trap.

Market participants frequently depend on technical patterns to dissect market trends and to assess investment strategies. Technical traders endeavor to distinguish bear traps and keep away from them by utilizing various logical tools that incorporate Fibonacci retracements, relative strength oscillators, and volume indicators. These tools can help traders comprehend and foresee whether the current price trend of a security is genuine and sustainable.

Bear Traps versus Short Selling

A bear is an investor or trader in the financial markets who accepts that the price of a security is going to decline. Bears may likewise accept that the overall course of a financial market might be in decline. A bearish investment strategy endeavors to profit from the decline in the price of an asset, and a short position is frequently executed to carry out this strategy.

A short position is a trading technique that gets shares or contracts of an asset from a broker through a margin account. The investor sells those borrowed instruments to buy them back when the price drops, booking a profit from the decline. At the point when a bearish investor erroneously distinguishes the decline in price, the risk of getting found out in a bear trap increases.

Short sellers are constrained to cover positions as prices rise to limit losses. A subsequent increase in buying activity can start further upside, which can keep on fueling price momentum. After short-sellers purchase, the instruments required to cover their short positions, the upward momentum of the asset will in general diminish.

A short seller risks boosting the loss or triggering a margin call when the value of an index or stock keeps on rising. An investor can limit damage from traps by putting stop losses while executing market orders.

Features

• A bear trap is a false technical indication of a reversal from a down-to an up-market that can draw clueless investors.
• A bear trap is much of the time set off by a decline that prompts market participants to open short sales, which then, at that point, lose value in a reversal when participants must cover the shorts.
• These can happen in a wide range of asset markets, including equities, futures, bonds, and currencies.