What Is a Bull Trap in Trading and How to Deal with It
What Is a Bull Trap in Trading?
There are many definitions of the bull trap, but we will use the easiest one. Every trader, even a newbie, knows that the price turns down near resistance and moves up near support. Still, when the price manages to break any of the levels, it's a sign of the strong trend that is supposed to prevail on the market.
Imagine the price grows, breaking above the resistance. What is the first thing you have in mind as an investor? Of course, you will buy as the trend promises to be bullish. However, the price bounces and moves down. Congratulations, you are in a bull trap.
There is an opposite situation when the price rises after the breakout of the support line. In this case, you are in a bear trap.
Why Do Traps Occur?
There are several reasons why the bull trap can happen:
- Unexpected market events. Trading is a subject of high volatility caused by the influence of unexpected events. Usually, it's political issues. It's impossible to predict what a politician will say or what will happen in the world in the future. Such unexpected events lead to rearrangements of market forces.
- Weak bulls. The bull trap on trading appears when bulls lose their force and can't push the price further up. Bulls can be weak due to several reasons. The most common ones are the lack of positive events and continued uptrend.
- Strong downtrend. If there is a strong downtrend and the price rises within it, the risks of the bull trap increase significantly.
So, the main reason for a bull trap in trading is the weakness of bulls that can’t push the price further up.
Bull Trap in Trading: Real Examples
Let's have a look at real examples of bull traps to have a clearer understanding.
On the H4 chart of EUR/USD, we can see that the price broke above the previous resistance within a strong bullish trend. However, it couldn’t stick above it. We can notice several retests of the previous resistance that became a support for the price. After the price fell below the support, a new downtrend started forming.
Another example of a bull trap was found on the daily chart of the EUR/USD pair. The price was forming a double top pattern. The price moved above the second top and moved down. After, the solid bearish trend formed. Later in the article, we will tell you more about the double top pattern.
A Bull Trap: How to Identify
As you have already understood, the bull trap is the pattern that can cause large losses. Thus, you should know how to prevent getting into a trap. Here are our tips:
- Check the candles' size. Usually, the price forms a bigger-than-previous candlestick at the final trap step. Of course, there is no 100% guarantee that it's a trap as an enormous candle can be a signal of a bulls' force. Still, be careful and wait for a confirmation from patterns or indicators, both should provide signals of the trend reversal.
- Notice resistance tests. If the price tests the resistance several times in the strong upward trend, it might be an indication of price reversal happening soon.
- Define sideways movement. If the price started moving horizontally within the uptrend, it's likely the uptrend will end soon. Thus, when the price breaks higher than the horizontal channel's upper line, stay away from the market to avoid a bull trap.
Bull Trap Chart Patterns
In this part of the article, you will find additional options to determine the bull trap in trading on the chart, noting specific patterns.
Bearish Engulfing Pattern
Such a pattern is formed after the formation of the bull trap. So, when you see that the price breaks above the resistance and the bearish engulfing pattern appears, it's a characteristic of a downtrend. The signal will be stronger if the bearish engulfing pattern follows the Doji candlestick that signals buyers' uncertainty.
If the price rises above the resistance and falls, it's not a 100% signal of the bull trap. It can be just a short-term correction. In this case, you should wait until the price breaks below the previous resistance (which has become support for the price). If the breakout occurs, the trend is expected to turn bearish. If the price just tests the support (previous resistance) and keeps growing, it's not a classic bull trap in trading.
Double Top Pattern
You should know that one of the easiest patterns is a double top pattern. It's formed before the bearish trend. The idea is simple: the price touches the resistance two times, forming two tops, then it starts declining.
In the bull trap case, the price should break above the resistance at the second top and then turn around. It doesn't matter whether it's a bull trap or a classic double top pattern - the price is supposed to decline.
How to Avoid Bull Traps
It's clear why you should avoid bull traps – because you are at risk of losing money. Imagine you open a buy position on the breakout but the price declines. You will simply lose. Below we have gathered the most efficient methods that will help you to deal with bull traps.
Method #1. Measure Volume
If you have never heard about the Volumes indicator, it's time to learn more about it. Although it seems that it barely provides trading signals, this instrument is widely used by traders.
Apply the indicator on the price chart and watch whether the volume is high on the resistance breakout. If the volume is significant, it's a sign of a strong uptrend. If the volume is low, there are risks of the trend reversal.
Method #2. Follow Candlesticks
There is a well-known candlestick that indicates market uncertainties - a Doji candle. If a Doji candlestick follows the breakout, there are odds of the downward movement as the market participants are unsure about the upcoming price direction.
Method #3. Be Careful with Pending Orders
The idea of the Buy Stop pending order is to open a trade when the price breaks above a certain level and keeps growing. Usually, traders put a Buy Stop pending order at the resistance level. You should be wiser and place the Buy Stop above the resistance level to be sure the price will increase.
Method #4. Learn How to Identify Traps Ahead
If you missed the part about identifying bull traps, you should get back to it and practice on a Libertex demo account.
Method #5. Don't Enter Late
The bull trap occurrence characterizes the end of the uptrend. If you see that the price has been trading up for an extended period (the period depends on the timeframe you trade), don't open a long position. Remember that trend is not constant - it changes from time to time.
How to Trade Bull Traps: Top Strategies
It’s better for traders to take time and wait until the patterns confirm the upward movement above the resistance level. Well, you may say that there is a huge disadvantage in avoiding trades. You can miss a perfect entry point if it's not a bull trap but a sustained bullish trend.
That's why we want to share with you some ideas on how to trade bull traps if you don't want to stay away from the market when the price breaks above resistance.
Strategy #1. Short
The best feature of trading is that you can both buy and sell no matter whether you own the asset or not. Thus, when the bull trap occurs, it's time to open a short position. The strategy is simple: wait until the market confirms the downtrend and become a seller.
Still, it's vital to be sure the bearish trend is forming. For that, you should follow the next step:
- If the price breaks below the previous resistance level, it's an excellent point to consider a short trade (1).
- Wait until the price tests the previous resistance after the trap. If the resistance isn't broken, it's the first sign of the strong downtrend (2).
- Another confirmation can appear from candlestick patterns, for instance, bearish engulfing, or indicators such as Awesome Oscillator or MACD. The RSI is also useful if you trade on big timeframes. For small timeframes, this indicator can provide fail signals.
- This strategy works for a strong downtrend. That's why the Take Profit order can be placed far from the entry point. For this, use trailing TP orders.
- Stop Loss should be placed slightly above the previous support level.
Strategy #2. When Resistance Turns Into Support
This strategy partially relates to the bull trap as it's not formed on a strong downtrend but a temporary price decrease.
Another strategy is to buy when the price tests the support level that was the resistance before. Imagine the price breaks above the resistance but turns around and falls. However, it doesn't slide below the previous resistance that has already become the support. It means that the trend is still strong. Thus, you can easily buy.
- Wait until the price breaks above the resistance and turns down (1).
- The price should not fall below the previous resistance significantly. Even if it breaks below, it's vital it turns around fast (2).
- It’s better if the price retests the support (previous resistance) at least two times. It will mean the uptrend is in force.
- You can go long after the second retest and a formation of the strong bullish candlestick.
- Take Profit order should be at the previous top. If this level is broken above, you can keep the position open using trailing Take Profit until the next previous top.
- As for the Stop Loss, it's worth placing it slightly below the support (previous resistance).
The bull trap is a harmful pattern for traders. Although you can use it in your favor, you better determine it ahead and avoid entering the market if there is any sign of its formation.
It's not easy to define bull traps on the price chart. A mistake can either cause a money loss or a missed opportunity of entering the market at a reasonable price. That's why you should practice daily.
The best option is to open a demo account. The Libertex demo account allows traders to open positions on various instruments, including CFDs, at real market conditions but with zero chance of losing their own funds. Although you won't earn anything trading on the demo account, you will gain skills that will help you in your future trader’s path.
Why to trade with Libertex?
- access to a demo account free of charge
- technical assistance to the operator 5 days a week, from 8 a.m. till 8 p.m. (Central European Standard Time)
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It's time to round up all the knowledge we got today.
What Does Bull Trap Mean in Trading?
The bull trap is a situation when the price breaks above the resistance, signaling a strong uptrend but turns around and declines.
Is the Market in a Bull Trap?
It depends on the market which we consider. There are plenty of assets, and there are many markets - conditions differ on each of them.
How Do Trapped Traders Make Money?
Although the trap is an unpleasant situation for traders, there is an opportunity to win if you know some secrets. Go back to the "How to Trade Bull Traps: Top Strategies" part to learn the best strategies.
What Is a Bull Trap in Crypto?
The bull trap in the crypto market doesn't differ from the basic explanation of the bull trap. The bull and bear traps are common market conditions for any asset.