Bear trap is a technical formation frequently encountered in financial markets, and it usually occurs when prices suddenly drop during an uptrend. This formation can cause investors to act on a misleading downtrend perception and result in losses when prices return to an uptrend. Therefore, it is important for investors to carefully monitor market trends and price movements and adjust their strategies accordingly to avoid falling into the bear trap.
In financial markets, a bear is an investor or trader who believes that the price of a particular security will decrease and takes a position in that direction. The bear trap is a coordinated practice by a group of traders who cause a short-term price drop in an asset, leading to panic selling.
Nasdaq defines the bear trap as a trading model where the price of a single stock or market suddenly drops sharply, but the market reverses the situation shortly without continuing the decline for long.
The bear trap first emerged as a technical event on traditional platforms and occurs when any index, stock, or other financial instruments falsely gives the impression of a rise followed by a decline. Asset prices can rise in a broad base trend, but can experience sudden stagnation or decline when they encounter resistance. In such cases, bears open short positions in line with their impressions of a price drop to profit.
How Does Bear Trap Work?
Bear traps generally arise with the aim of influencing the current price of a particular cryptocurrency by a group of traders. Afterwards, this group of traders attempts to trigger panic selling by investors who have invested in the same cryptocurrency.
Bear traps are mostly executed during bull markets, giving the impression that a cryptocurrency is on a downward trend, and thus causing investors to panic sell. Afterwards, one or more whales behind the bear trap start buying the asset at a low price. Individuals and traders looking to take advantage of the bear trap first wait for the price to hit rock bottom.
What Are a Bear Trap and Bull Trap? What Are Their Differences?
There are two types of traps that should be paid attention to in cryptocurrency markets:
- Bear trap
- Bull trap
It is possible to predict which one will occur by looking at the conditions and trends of the market.
When the trend is rising and suddenly undergoes a downward correction or a reversal movement, we define this as a bear trap. When stock prices fall due to a bear trap, investors may want to make a profit by taking short positions. However, when prices start to fall further, buyers take advantage of this opportunity and increase their buying activity, but the market does not support this decline any further. Thus, prices continue to rise rapidly again.
Traders can use a strategy of selling a stock at a certain price and then buying it back at a lower price when they are in a short position. However, if prices continue to rise, traders may incur losses.
How to Avoid a Bear Trap?
There are ways to determine whether a drop is a bear trap or not in order to avoid traps. These are:
- Observing transaction volume
- Using trading tools
- Technical analysis
- Candlestick charts
Observing Transaction Volume
If the current instrument's transaction volume is low, it may indicate a temporary change in price.
Using Trading Tools
By using stop orders and selling options in your trading tools, you can avoid losses in temporary short-term bearish trends.
Technical Analysis
Technical analysis tools such as Fibonacci retracements and relative strength index can provide realistic clues as to whether a security is in a continuous or temporary downtrend.
Candlestick Charts
Candlestick charts can easily help you identify a bear trap when used correctly.
