How to avoid a bull trap?
The cryptocurrency market has its own set of tricks, so today we’ll take a deeper look at one of them, called bull traps. As long as the market is still heading lower, this pattern lures traders into buying. The repercussions might be very serious if you fall victim to this trap.
What is a bull trap?
A bull trap occurs when a trader purchases an asset with the expectation that its price will increase further only to witness a rapid decline after it reaches a new high.
Bull traps happen when the market is unsure or when untrue information about a specific asset is being spread. It’s dubbed a bull “trap” because uninformed traders are led to assume that an asset that is decreasing is actually rising. An erroneous sense of security can result in significant losses.
Traders should quickly stop the transaction or take a short position when they fear a bull trap. In these situations, stop-loss orders might be useful to prevent being carried away by emotions, especially if the market is moving quickly.
Bull trap detection can be challenging, as it is with many other trading-related tasks. The greatest method to avoid bull traps, though, is to stay alert for early warning indicators, such as low-volume breakouts. We’ll talk more about this below.
How does a bull trap work?
For individuals that invest during what they believe to be a turning point, bull traps can have serious repercussions.
Imagine you are viewing a down-trending asset chart. After some time, the price reaches a spot where it begins to consolidate in a sideways pattern known as a “range.”
The bulls and bears are engaged in a struggle to move the price in opposing directions throughout this time. The bulls are attempting to keep the price up while the bears are trying to drive it to new lows.
The price eventually breaks out of the range as the bears win and the price drops to a new low. But, the bulls make a comeback and drive the price back up to its prior high just as it appears that the downturn is ready to start.
Many traders interpret this as a bullish turnaround and begin purchasing, believing that the downturn is over. Sadly, this is frequently only a passing trend, and the price quickly returns to its downward trend, causing significant losses for those who purchased at or close to the top.
In the crypto space, what is a bull trap?
Bull traps, which are also known as “dead cat bounce,” are frequently seen in the cryptocurrency world because of their quick recoveries.
Bull traps function in the cryptocurrency market just like they do in conventional markets. For instance, you would assume that if the price of a cryptocurrency has been gradually increasing over the past few days, it will do so going forward. You purchase a certain amount and watch for the price to rise before selling it for a profit.
Unfortunately, the opposite occurs, and you end up in a losing situation. You observe the decline and then watch for a bullish reversal when you may buy the dip, fooling yourself into thinking you’re getting the asset for a good deal. When the price declines and resumes its downward path, the trap becomes apparent.
Bull traps: The psychological aspect
Bulls pursue and enjoy the high of bull market conditions, which may be all good until the next bad market appears.
When this occurs, individuals run the risk of being ensnared in a bear trap and losing all of their investment. Those used to trading in a bull market may make the mistake of purchasing high and selling low due to a unidirectional attitude (strictly bear or bull). To win in both bull and bear markets, experts advise adopting a bidirectional mentality, as this enables better earnings throughout long-term trends.
What is the purpose of bull traps?
Both day traders and long-term investors utilize bull traps to take advantage of unwary market players.
Bull traps offer long-term investors the chance to purchase a security at a lower price as it declines after a rally. They can then keep the security for the following rise.
Recognizing a bull trap
Here are some warning signs that a bull trap is approaching and how to recognize one:
An indication of a probable bull or bear trap could be a high RSI.
Calculating the relative strength index (RSI) might help you spot potential bull or bear traps. Technical indicators like the RSI can show whether a cryptocurrency asset is neither overbought nor underbought, or both.
The RSI uses the following formula:
RSI = 100 — (100/ (1+ (average gains at closing/average losses at closing)))
Although it can be used for other time periods as well, the calculation typically covers a period of 14 days. Since it is not included in the formula, the period has no effect on the calculation.
A high RSI and overbought conditions imply that selling pressure is escalating in the case of a potential bull trap. Since traders want to keep their profits, they are likely to close the deal at any time. The first breakout and uptrend may not therefore be a sign of further price increases.
Poor volume growth
Volume should noticeably rise when the market is genuinely breaking out to the upside since more individuals are purchasing the asset as it rises in price.
There may not be much interest in the asset at that price and the rally may not be long-lasting if volume increases only slightly or not at all on the breakout.
Lack of momentum
A bull trap is apparent when an asset undergoes a dramatic decline or gap-down with big red candles followed by a very gentle rebound.
The market moves in cycles by nature. A cycle’s peak is typically marked by consolidation as bulls and bears struggle for dominance.
This lack of momentum can be viewed as a precursor to the market’s impending reversal.
Absence of a trend break
A series of lower lows and lower highs indicate a price drop.
As advancements are made, trends in asset prices don’t necessarily shift. As long as the price gain falls short of the most recent lower high, a downtrend is still present.
One of the most common errors made by people caught in bull traps is a lack of confirmation. People ought to be aware that it is in a downtrend or range if the current high does not exceed the previous high.
This is often regarded as “no man’s land,” one of the worst places to start a transaction unless you have a compelling reason to do so.
Although some traders might be disappointed by this, the majority are better off waiting for confirmation and buying at a higher price than attempting to “get in early” and being trapped.
Checking the resistance level again
The first sign of an impending bull trap is a strong bullish momentum that has been sustained for a long time yet reacts quickly to a specific resistance zone.
When a crypto asset develops a strong uptrend and experiences little bearish pressure, it suggests that buyers are pouring all of their resources into it.
Yet the price usually reverses before rising further higher when it encounters a resistance level that they are hesitant or afraid to break.
Abnormally large bullish candlestick
At the last phase of the trap, a massive bullish candle typically occupies the majority of the nearby candlesticks to the left.
The bulls typically use this as a last-ditch effort to seize control of the market before the price turns around.
Formation of a range
Bull trap configurations also produce range-like patterns on the resistance level, which is their final distinguishing characteristic.
When the price of an asset varies within a range, it is said to “bounce” back and forth between a support and resistance level.
This range may not be ideal, especially at the top end, as the market could still be producing smaller, higher highs. But, as the enormous candle mentioned earlier forms and shuts outside of this region, the beginning of the bull trap is apparent.
In general, it is critical for investors to be careful, regularly follow the market, and avoid making rash investment decisions based on passing trends or feelings in order to spot potential bull traps. Investors can lower their chance of falling for bull traps and make better judgments by undertaking rigorous research and analysis.
Disclaimer: The information herein is for educational purposes only and should not be considered financial, investment, or trading advice. Please conduct your own research and due diligence before making investment decisions. You understand that you are using the Information provided at your own risk.