What Is a Bull Trap?
A bull trap is a false signal, alluding to a declining trend in a stock, index, or other security that reverses after a persuading rally and breaks a prior support level. The move "traps" traders or investors that followed up on the buy signal and produces losses on coming about long positions. A bull trap may likewise allude to a whipsaw pattern.
Something contrary to a bull trap is a bear trap, which happens when sellers fail to press a decline below a breakdown level.
Understanding a Bull Trap
A bull trap happens when a trader or investor buys a security that breaks out over a resistance level — a common technical examination based strategy. While numerous breakouts are followed by strong moves higher, the security may rapidly reverse course. These are known as "bull traps" since traders and investors who bought the breakout are "trapped" in the trade.
Traders and investors can stay away from bull traps by searching for confirmations following a breakout. For instance, a trader might search for higher than average volume and bullish candlesticks following a breakout to affirm that price is probably going to move higher. A breakout that produces low volume and hesitant candles —, for example, a doji star — could be an indication of a bull trap.
From a mental viewpoint, bull traps happen when bulls fail to support a rally over a breakout level, which could be due to a lack of momentum or potentially profit-taking. Bears might energetically take advantage of the chance to sell the security in the event that they see divergences, dropping prices below resistance levels, which can trigger stop-loss orders.
The best method for dealing with bull traps is to perceive warning signs ahead of time, for example, low volume breakouts, and exit the trade as fast as could really be expected in the event that a bull trap is thought. Stop-loss orders can be useful in these conditions, particularly on the off chance that the market is moving rapidly, to abstain from allowing feeling to drive navigation.
Illustration of a Bull Trap
In this model, the security sells off and hits another 52-week low before bouncing back strongly on high volume and lifting into trendline resistance. Numerous traders and investors bounce on to the move, expecting a breakout above trendline resistance however the security reverses at resistance and diverts pointedly lower from these levels. New bulls get trapped in long trades and bring about quick losses, except if aggressive risk management procedures are embraced.
The trader or investor might have stayed away from the bull trap by waiting for a breakout to unfurl before purchasing the security, or if nothing else relieved losses by setting a tight stop-loss order just below the breakout level.
- Bull traps happen when buyers fail to support a rally over a breakout level.
- A bull trap means a reversal that powers market participants on some unacceptable side of price action to exit positions with unforeseen losses.
- Traders and investors can lower the frequency of bull traps by seeking confirmation following a breakout through technical indicators or potentially pattern divergences.