Key Takeaways
- Bull traps occur when the price surges during the Bear market before suddenly declining, while in a Bear trap, the prices suddenly drop before reversing and increasing.
- A sudden, unexpected price hike can identify a bull and bear trap caused by sudden panic selling when prices drop sharply.
- You can avoid Bull traps and Bear traps by learning to use technical indicators and pattern divergences to confirm breakouts and understanding the biases and psychological factors that lead to them.
Apart from being highly volatile, the cryptocurrency market is unpredictable and also vulnerable to some level of manipulation. Bull traps and bear traps are among the most common tactics that can cause investors to lose money because they can’t identify them. This article explores these two concepts and offers practical ways to avoid them.
What is a Bear Trap in Crypto?
A bull trap refers to a situation in crypto trading when signals show that a digital asset’s price is falling. This attracts short sellers who position themselves in readiness for a price drop. Unfortunately, this is usually a false signal because once the crypto reaches a new low level, it rebounds fast and sharply. When you look at the situation in a chart, the problem seems like a breakout below a support level. However, it’s followed by a quick reversal, leaving a long wick.
The term bear traps originates from the way bearish traders get trapped. These investors mostly end up making losses and remain psychologically vulnerable because they have to choose between accepting the losses or risk holding on to their new position and making even greater losses. In trying to cover these shorts by hurriedly buying back their position, the traders fuel a bear trap and drive prices higher as they rush to exit the market to avoid further losses. Moreover, long traders who expect a reversal are stopped during bear traps.
Bear traps are mainly psychological since they happen when an overwhelming negative market sentiment leads traders to expect prices to continue falling. Institutional crypto market players have learned the science of capitalizing on this negativity. They take long positions, pushing the prices down momentarily and trapping many short traders, triggering long stop-losses. Other traders begin buying when shorts start covering, pushing prices up and leading the players into profitability.
What Is a Bull Trap in Crypto?
Bull traps, on the other hand, are the exact opposite of bear traps. In this situation, prices start rising unexpectedly, and traders are lured into buying. A bull trap quickly makes a new high and then reverses soon after that, so traders who invested during the false breakout end up making losses.
Just like bear traps, bull traps are the result of emotional buying. Once the bull traders have been trapped, they immediately realize they are going to incur a loss. When bear traders who correctly predicted the looming downward trend get stopped, they look for another entry. The fear and frustration that follow these bull traders and bear traders create selling pressure, leading to even lower prices.
As the prices move lower, the bear trap makes the price rise once more, creating the real bull trap. In such a scenario, traders who rush to buy the breakout are led to believe that the high is finally broken, and they open long positions while the short traders that reentered the market get stopped again. As prices begin to fall sharply, traders realize the proper market position, leading to even lower prices as traders now flock to the short positions.
How to Avoid Bear and Bull Traps
Unless knowledgeable and careful, it’s easy to fall into bull and bear traps when trading crypto. The following are among the precautionary steps you can take to play safe and avoid frustration and potential losses associated with the bear traps and bull traps:
Learn Where Liquidity Lies
Bull traps and bear traps accomplish two primary purposes: playing on crypto traders’ emotions and tapping into liquidity. With liquidity, traders can take prominent positions without necessarily impacting a cryptocurrency’s price and reduce transaction costs. Liquidity mainly occurs just above support or resistance levels where traders place stop losses, and breakout traders wait so they get trapped before a considerable move happens.
Liquidity mainly builds along trend lines or next to areas close to equal highs and lows and close to round numbers (e.g., $90,000), but they can also be found above every high and low. During any scenario where you get tempted to place orders around any of the mentioned areas, it’s advisable to consider a wider stop-loss. The best place to start is always ahead of the following significant resistance or support level.
Learn Trading with the Trend
In most cases, bear and bull traps happen in the direction of popular broad trends. For example, traders must consider taking a long position when the market shows a bearish trend based on a potential breakout. Similarly, a wise trader should consider holding off from initiating short positions when the general market trend is bullish. While trading along the trending position doesn’t mean counter-trending opportunities, it means approaching every position cautiously.
Check Trading Volumes
The size of trading volumes should give traders an idea of ongoing market activity. Generally, price movements accompanying high trade volumes could indicate a genuine breakout, and low volumes could suggest a looming trap. However, this isn’t always true because bear and bull traps can generate sufficient volumes. As a result, traders need to compare recent volume breakouts to discover whether they’re a potential trap to gauge the market’s strength.
Conclusion
Bull and bear traps are just among the many challenges you will face as a cryptocurrency trader. Taking the time to learn the mechanics of crypto trade will help you understand these traps and how to avoid them to reduce potential losses while taking advantage of available opportunities to increase your chances of making profits.
