bear trap analysis

False Technical Indicator of a Reversal

Tue Jan 04 2022 18:20
A bear trap is a risky event that can make one incur losses. Therefore, avoiding them is the best when trading. 

 Trading stock and financial markets mean getting the right opportunity to buy without too much risk. People apply different trading strategies. 

However, not all plans are profitable, and only quite a few are good. All trading strategies also have a negative side. Therefore, we should look at the positive side of each and watch out for trading traps. It is essential to differentiate between the opportunities and traps.

One of the most common traps experience by many traders is the bear trap. If you constantly trade, you are likely to experience or have been a bear trap victim in Forex trading

 Most trading opportunities turn out to be different from what they appeared before entering the trade and turn out to become false breakouts. 

By reading the article, you will be able to identify what is bear trap trading and how to avoid it when trading.

What is Bear Trap Trading?

A bear trap is a condition in the market where an expected downward trend of prices falls and suddenly rises. The technical stock trading pattern indicates a misleading reversal of an upward trend. 

The bear trap trading happens when an increasing stock market trade stops and a downward price movement begins. The momentum transforms into a market reversal combined with a sharp rally that creates a trap for traders. 

The trading institutions set the trap by pushing the stock prices below to increase the demand and drive stock prices higher. Traders then place their stops above the moving average that is supposed to become a resistance when broken. 

However, no proper breakout occurs, but just a piercing of the moving average before the prices go up again. Traders who sell their stakes when the piercing occurs always find themselves on the wrong side. 

In simple terms, the bear trap explained for beginners means a situation where indexes, financial assets, and stocks issue a false signal of an upward trend in the financial market. 

During this period, most traders expect a downward movement in prices as the prices increase or remain unchanged. Bear traps deceive traders since most of them work using trade signals. Most traders incur huge losses when they invest during this period.

What causes a Bear Trap to Occur?

Below are the two main reasons that try to explain the occurrence of bear traps in trading;
  • Generally, a common technical analysis-based strategy exists in financial trading, where traders sell stocks that break out of the moving average. The sale process begins when the prices move below the support level. Strong downward shifts follow breakouts, but it does not always occur. During this period, traders who engage in trading are caught in the bear trap.
  • In most cases, traders place stop-losses above the moving average. The moving average intends to turn to resistance if the prices break it evenly. However, proper breakout rarely occurs, and piercing occurs, followed by an increase in prices. During this period, investors who engage in trading become victims of the bear trap.
Bear traps affect the overall morale of investors who begin to suspect their trading abilities. Therefore, trading institutions should develop strategies to help avoid the bear trap before engaging in any business.

How can you identify a Bear Trap?

As mentioned above, a bear trap can cause significant losses. It is important to identify bear traps to avoid being caught in a bear trap. Some of the technical indicators to watch out for include:

1. Look out for the Market Volume

Market volume is an important indicator of a bear trap. It is easy to note a difference in the market volume when the prices are rising or falling. If there is no change in the market volume when the prices drop, then there is a likelihood for a bear trap to occur. Low market volumes indicate a bear trap since bears rarely pull the price down.

2. Check out the Fibonacci Level

Experts use fibo ratios to identify trend reversals. Therefore, it is easy to identify bear traps using Fibonacci levels since they indicate a reversal of prices in the market. The price or trend does not break the Fibonacci level when a bear trap occurs.

3. Identify Divergence Signals

Several indicators provide traders with divergence signals. The presence of divergence means that a bear trap exists. To identify a divergence, check whether the indicator and market prices are shifting in the opposite direction.

When the price and indicator move in a similar direction, there is no divergence; hence, no bear trap occurs.

Bear Trap - Top 4 best Strategies to help Avoid Bear traps

Bear traps are risky, and the best way to avoid using the bear trap in trading is by avoiding them. Being caught in a bear trap can make you incur huge losses. 

One can apply different strategies to avoid incurring losses due to bear traps. However, some of the strategies do not work. Below are some of the top 4 proven strategies that can help you avoid getting caught in a 'Bear Trap'

a) Follow the Market Volume

It is important to check the market volume to identify whether it is strong enough to trade. 

The volume reflects the strength of the bear trap. If the indicator does not display increased values, the bears have enough strength to make the prices shift downwards after the breakout. Therefore, it is important to avoid entering the market during this period.

b) Trading Candlestick Patterns

Candlesticks provide a more reliable signal to identify bear traps. It is important to learn more about the most famous types of candlesticks. The decline may not persist when the market creates a reverse candlestick pattern immediately after a downward breakout. 

You can also consider the Doji candlestick pattern that reflects uncertainties. The Doji candlestick helps clear doubts about the market future since it follows the breakout.

c) Identify the Traps in Advance and Limit Orders

It is difficult to identify a bear trap, but it is possible. The article provides the different methods you can use to identify bear traps. You can limit the orders during a bear trap by enabling the stop-loss orders.

You can achieve this by placing them under the resistance and support line. They act as a buffer zone that provides a breather if a false breakout happens.

d) Check the length of a downtrend

Bear traps normally occur when there is a downtrend. The overall idea of the financial institution is to sell during the upward price trend. It is important to avoid selling during a downtrend. 

Selling during downtrends only makes sense if the situation persists for a long time. Most people wonder how to identify an already formed downtrend or whether it is still likely to decline. 

It is important to compare the length with the timeframe. However, it is recommendable to enter the market when the prices turn around and not when a downtrend exists.

The Bottom Line on what is Bear Trap Trading

Forex trading is one of the best ways to increase your investments. However, it is easy to fall into a trap when constantly trading on the platform. 

Most people incur losses since they cannot identify bear traps during Forex trading. Identifying the bear trap is an easy task. Even with all the knowledge, you are likely to become a victim of bear traps. 

These difficulties created the need to develop the Xosignals.com app to help identify Forex trading signals. The software helps you analyze the situation before investing your money. 

Download the app today on your mobile phone and analyze trading patterns to help you identify the best time to trade.
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