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Capital markets like crypto, stocks and forex are full of traps designed to prey on unsuspecting and emotional retail traders. Two of the most common are bear traps and bull traps.
In this post, you’ll learn how to spot and think through these traps in order to become a better and more profitable cryptocurrency trader.
What is a bear trap?
A bear trap is a rapid price decrease in an uptrend.
After the trap phase, price shoots back up leaving bears in a bad trade.
What is a bull trap?
A bull trap is a sudden price increase in a downtrend.
Like its bear counterpart, a bull trap gives a false sense of price reversal. In this case, a bull trap is designed to lure unsuspecting traders into opening long positions on an asset.
After the trap phase, price continues downward and bulls become trapped.
Examples of bear traps and bull traps
Take a look at this screenshot of the ICX/USDT 1-hour chart:
- A shows a clear support line around the USD0.84 area.
- Following a correction from USD0.92, B shows a break in the support line.
- Some traders may see this support break as an opportunity to enter a short position. However, price quickly recovers and shoots up to USD1.00.
- C shows the rapid price increase, also called a short squeeze. Following the short squeeze, bears are forced to sell off their positions to minimize losses or prevent liquidation.
- After the bear trap is over, D shows the price of ICX continues its original downtrend.
Next up is a bull trap on the 15-minute ETH/USD chart:
- A shows strong resistance at USD409.50.
- B depicts higher lows which suggest a bullish undertone.
- C shows a breakout to USD413 with a subsequent support test at D of a previous resistance level.
- The support breaks a little on the first retest, but holds on the second.
- At this point, price rises again at F, causing bullish traders to enter long positions after seeing support at USD409.50.
- This particular bull trap tests the USD413.50 high twice before breaking support and causing the price to fall down to USD402.
Finally, here’s a chart showing both bull and bear traps on a BTC/USD 4-hour chart. There’s a lot going here, but let’s break it down.
- A shows Bitcoin forming a double bottom in the $5900 range.
- Next, price jumps up into an ascending channel, depicted by B.
- In this channel, Bitcoin consistently forms higher highs and higher lows over a one-week period.
- C shows Bitcoin breaking the channel support at USD6,500.
- Since this is a 4h swing trading chart, this support break can be interpreted as severe, causing bears to open short positions.
- Over the next few days, Bitcoin drops to USD6,200.
- E shows the bear trap in full swing as price catapults to USD7,600 before hitting a high of USD8,500.
- At this point, bears holding short positions were either liquidated or forced to close their orders at a loss.
The drama isn’t over yet.
- After large upside movement, many traders take profits, and we can see this in the slight retracement from USD8,300 to USD7,900.
- After profit-taking, Bitcoin shoots back up to USD8,200.
- As shown by J, bulls may choose to enter into long positions with the hope of a further rise past USD8,500.
- Instead, price consolidates in the USD8,200-8,300 range before tumbling back down to the USD5,900-6,000 range, forming a triple bottom.
- In the end, the bulls who chose to open longs suffered significant losses or forced liquidation.
How to avoid bear and bull traps
Now that you know what bear and bull traps look like, here are a few tips on how to avoid getting stuck in a trapped trade.
Check the volume
Real price reversals require a significant amount of volume. If you see a sudden reversal without a large amount of volume behind it, it’s most likely a trap. Here’s the BTC/USD 4-hour chart again.
Look at the sell volume at the channel support break depicted by D. The price drop from USD6,700 to USD6,200 was caused by a fairly low volume selloff.
Look for RSI divergence
RSI oscillates between 0 and 100. An RSI under 25 indicates oversold conditions, while an RSI over 75 suggests overbought conditions. As price moves up, RSI also increases if there is momentum and support behind the price increase.
Similarly, RSI typically decreases when price moves downward.
Divergence occurs when price and RSI move in opposite directions, and suggests an asset’s price movement is weak and not backed by significant momentum.
Divergence usually leads to a price reversal in the opposite direction. Take a look at the ETH/USD 15-minute chart from earlier.
When ETH reaches USD413.50 for the first time, we can see RSI at 80, indicated by E.
This shows overbought conditions and imminent price reversal, and that’s exactly what happened with the retracement down to USD408.50. During the next two moves up to USD413.50, ETH seems to form an ascending channel, which is typically a bullish indicator.
However, the RSI chart tells a completely different story. By the third test of USD413.50, RSI has dropped to 50, which suggests there is little momentum behind the move.
This is also evident by the lack of buy volume. As expected, the divergence led to a complete breakdown to USD402. This shows the importance of trading with indicators. In this scenario, a trader using only candlestick action to enter a trade would have fallen into a bull trap.
We can see another example of RSI divergence on the BTC/USD 4-hour chart.
The first move from USD6,200 to USD7,600 is supported by adequate buy volume, and this is reflected in the RSI moving from 25 to 75.
However, the subsequent move from USD7600 to USD8500 happens with declining RSI, as shown by H.
Once again, candlestick trading would’ve suggested further bull movement following the USD7,900 retest at J. However, this subsequent move back up to USD8,200 had very little buy support, and price eventually broke downward back to USD6000.
Check the News
News, whether it’s good or bad, can have a significant emotional effect on inexperienced traders and lead to poor irrational trading decisions.
Market makers know this and often use news to initiate bull or bear traps. If you see a sudden price movement with average volume, be sure to check the news before making any trading decisions.
More often than not, movements like these are simply designed to catch emotional traders off guard.
Use stop-loss orders
Using stop-loss orders is a crucial part of any successful trading strategy. Even if you feel completely confident about a trade, the market can still completely go against you.
It's important to set a strict loss allowance by closing a position if a trade goes the wrong way. 1-2% loss of your starting capital can be a good starting point.
It can be wise to always use a stop loss order to build potential losses into your trading strategy and minimize emotional turmoil. Don’t expect the market to recover in your favor because many times, it simply won’t.
Bear and bull traps are one of the most common trading pitfalls when trading cryptocurrency. Thankfully, it’s easy to minimize losses due to traps if you have the right cryptocurrency trading strategy and mindset.
WRITTEN BYBrian Li
Trader, analyst, Liquid contributor. Editor of Decrypto.net.