What is a bull trap in trading and how to avoid it?

Main

• A bull trap is a trading term that describes a situation where the market “deceived” investors by giving a false signal to buy an asset, but reversed.
• A bull trap occurs due to the inability or unwillingness of traders to sustain an uptrend.
• The likelihood of falling into a bull trap increases if an investor makes emotional, hasty, and thoughtless decisions based on limited trading tools.

How do they fall into the bull trap?

This situation occurs when the first signs of continued growth appear on the market or a possible change in the downward price movement of the asset to an upward one. The “trick” of the market lies in the fact that buyers predict a continuation of the upward trend in prices, that is, the dominance of “bulls”, while sellers (“bears”) represent the real force in the market.

For example, a bull trap can form on a down move when the price of an asset rises above a resistance level after breaking it up. In this case, traders may perceive that the market is indicating a reversal and demand from buyers. Then they start buying the asset with the expectation of further price movement upwards, after which the sellers turn out to be “stronger”, and the quote price returns to a downward movement.

In addition to the bull trap, trading also uses the “bear trap” situation, when the market “deceives” sellers. Many cryptocurrency traders fell into such a trap in mid-2020, before the start of another bullish rally in 2020-2021.

What is a bull trap used for?

The bull trap is a logical way to create favorable price conditions for sellers: the higher the selling price, the more profit can be made by getting rid of the asset.

To create a bull trap when trading Bitcoin and other cryptocurrencies, large traders acting as “bears” use a weak upward trend in prices. They do not interfere with the formation of conditions for increasing quotes and can even push the crypto asset to price levels that are promising for buyers.

Because of this, an illusion of favorable conditions is created for the continued growth of the asset price and the dominance of buyers over sellers in the market. A bull trap is not necessarily a “man-made” process and may result from a short-term positive market reaction to a news or event.

Why do they fall into the bull trap?

Despite the complexity and versatility of the markets, there are several main causes of the bull trap.

Emotions. Emotional market participants are most prone to making rash trading decisions. Any minimal increase or rebound in price is perceived as a reversal and a buy signal, which leads to hasty conclusions and, as a result, losses.

Trading instruments. Traders who make decisions based on a small number of factors and indicators do not see the full picture of what is happening. For example, a sharp rise in price will not be a sufficient signal to buy if the trading volumes at the time of the price rise are significantly lower than previous periods.

Psychology. Traders who have convinced themselves of a market reversal before it even starts ignore the signals or try to come up with non-existent confirmations in order to “fit” the interpretation to their own strategy.

How not to fall into the bull trap?

A bull trap can happen in a variety of circumstances, but there are ways in trading to reduce the risk of falling into it.

A bull trap is forming above the resistance level, and you need to wait for it to be retested to see how the market reacts. Successfully fixing the price above the target mark significantly reduces the likelihood of falling into a trap.

A trader needs to monitor the volume of asset trading. A strong upward movement of quotes with increased volume may mean an increase in buyers’ interest. Rising prices without increased volume can signal weakness in buyers and a temporary respite for sellers, which entails a bull trap.

As an additional method, technical analysis tools are used, in particular Relative Strength Index (RSI), Stochastic Oscillator and Moving Average Convergence Divergence (MACD).