A bear trap refers to a false technical indication of a reversal from an uptrending market to a down-trending market.
Bear traps occur in all asset markets including currencies and cryptocurrencies.
Bear traps can manifest as a form of downside market correction within an overall bullish move higher.
While it’s a difficult proposition for novice traders, they can use charting tools to recognize a bear trap.
A bear trap refers to a technical pattern that forms when the price action of a stock or any other financial instrument incorrectly signals a reversal from an uptrend to downtrend. In simpler terms, the prices may move higher in a broad-based incline. It then encounters significant fundamental resistance or change, prompting bears to open short positions.
In the cryptocurrency market, a bear trap generally involves several traders who have a significant amount of combined cryptocurrency holdings. They can plan to sell a large amount of a particular coin at the same time. This produces a false indication that other market participants think that a price correction is taking place. They sell their own holdings in response, which drives prices down even further. Once the bear trap is released, the group buys back their assets at a lower price. This leads to the value of that coin rebounding, allowing the trap setters to make a profit.
How does a Bear Trap work in the Crypto Market?
More often than not, novice traders get caught out by price volatility when trading in the cryptocurrency market. While it is always recommended to stay for the long term to ride out such volatility, price reversals can confuse even the most experienced traders. This makes it crucial for traders to identify the signs of a false reversal. Increased volatility can lure short-term traders to time the markets, resulting in losses for the majority.
For markets which trend upwards, a sudden downward price move can increase volatility, forcing market participants to go short on the underlying asset or liquidate long-term holdings. This form of market manipulation is called a bear trap in crypto. The main aim of this move is to deceive bearish participants into believing that it is an indication of the start of a downtrend. It is often followed by a sharp resumption of the previous uptrend.
How do groups of traders take advantage of a crypto bear trap?
Groups of traders coordinate with each other for the collective selling of a particular token. This causes the token’s price to fall, influencing other retail participants to believe that the uptrend is over.
As a result, many investors tend to sell their holdings which decreases the price even further. The influential trader groups then proceed to buy back the sold quantities of tokens when they break below the previously held lows. This triggers a sharp upward move that entraps bearish bets. As a result, the trader group profits from the difference by selling at a higher price and buying them back at a lower price.
How can traders identify and avoid a bear trap?
Traders can use trading indicators and technical analysis tools such as volume indicators, Fibonacci levels and RSI to identify a bear trap. They can use these tools to confirm whether the trend reversal after consistent upward price movement is genuine or false.
To ensure that there isn’t a bear trap, traders must check whether the downtrend is driven by high-trading volumes. Some of the most tell-tale signs of a bear trap forming include a combination of factors such as the retracement of the price below a key support level, low volumes and failure to close below critical Fibonacci levels.
Crypto investors who have a low-risk appetite should avoid trading during price reversals which are abrupt and unsubstantiated. They should check whether the price and volume action confirms a trend reversal below any important support level. For traders, it makes sense to hold their cryptos and avoid selling unless the price has breached the stop-loss level or the initial purchase price.
Every trader must understand how crypto react to crowd psychology, sentiments and news if they want to avoid a bear trap. This is easier said than done, due to a large amount of volatility in the crypto market.
Traders who want to profit can get into a put option and avoid becoming a short-seller or long-seller. A put option avoids the exposure to unlimited risk if the crypto resumes its upward trend, which is not the case with short-selling.
By getting into a put option, a trader limits his/her losses to the premium paid. It prevents it from affecting the long crypto position being held from before. In the case of long-term investors, it is better to stay away from trading during a bear trap.
Can a bear trap be traded by bullish or bearish traders?
Since a bear trap comprises both a downward and upward move, both bearish and bullish traders can trade it using different strategies with potential outcomes.
How does a bear trap differ from a bull trap?
A bull trap is the opposite of a bear trap. Here, traders assume a downward trend is reversing and beginning to take long positions, only to realize later that the market has resumed its downward trend.
Can traders recover from a bear trap?
If a trader gets caught in a bear trap, his/her PnL will get hurt significantly since these traps are quick moves which provide no chances to recover. To conserve their PnL, traders must understand the underlying market movement during a bear trap to identify it.