Bull Trap

November 21, 2023 - Around 3 mins mins to read

Understanding the Bull Trap Phenomenon

A bull trap, also known as a “whipsaw pattern,” is a deceptive market signal that can occur on various assets, including cryptocurrencies, during a prolonged downward trend. It gives a false indication of recovery or reversal in the value of a stock, cryptocurrency, or any other financial asset. The trap tricks traders and long-term investors into believing that the asset is about to rise, when in reality, it is actually poised for further decline. This trap is set when the price of an asset surpasses its previous support levels, enticing traders to open new long positions or purchase more of the asset.

Bull traps are notorious for their deceptive nature and the negative consequences they can have on market participants. They are appropriately named “traps” because they mislead traders into making unfavorable decisions. This is why it is crucial for traders to exercise caution when they encounter a sharp reversal in an asset’s price after a breakout, which is a price movement below a support level. Unfortunately, many retail investors, especially in the cryptocurrency space, expect a breakout to always lead to a strong price rally, but this is not always the case.

Technical analysis plays a vital role for day traders as it involves analyzing price patterns and identifying trading signals on an asset’s price chart to predict future movements. One significant signal is a breakout above a resistance level, which occurs when the price chart surpasses a line that has been repeatedly reached but never exceeded before.

This breakout often leads bullish traders to anticipate further price increases and take long positions on the asset. However, a bull trap happens when this signal proves to be false, and the price quickly resumes its downward trend after breaking above the resistance line. As a result, traders who bought the asset based on the misleading signal find themselves trapped in losing trades.

To avoid falling into a bull trap, traders can take extra precautions by seeking additional confirmation signals of a sustained bull run following the initial breakout above the resistance level. Breakouts accompanied by low trading volume often indicate an impending bull trap.

Since bull traps occur when bullish traders fail to sustain the upward trend following a resistance breakout, low trading volumes during breakouts serve as reliable indicators. Therefore, to protect oneself from falling victim to a bull trap, it is essential to consider other factors such as trading volume and subsequent price movements before entering new positions after a price breakout. Experienced market players refer to this practice as seeking “confirmations,” where traders observe an asset’s movement in the next time period before making a decision to enter new positions.