A bear trap is a trading pattern reflecting a misleading reversal, a temporary but sudden downtrend after a long-term uptrend that is quickly followed by a sharp stock rally.
In other words, a bear trap is an investing pattern that happens when falling security that is losing its value suddenly starts reversing and begins gaining value instead. It means an upward market trend suddenly stops, and a short-term downward price movement starts. It also happens when a stock begins falling unexpectedly, Thereby maintaining an upward trend.
This bearish momentum quickly transforms into a market reversal, followed by a sharp rally, creating a trap for traders. During this time, bearish investors who have shorted or bet against that stock may face some losses.
This is usually done by institutions to set up the trap by pushing the prices lower to create more demands and drive prices higher. The prices of a particular token fall also by mutual coordination among the sellers.
They collectively sell a specific token which causes it to drop. Aside from stocks, the pattern is more common in trading equities, currencies, bonds, cryptocurrencies, CFDs, and futures.
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How does a bear trap work in crypto markets?
A Bear trap is a sort of manipulation. Traders can identify a bear market based on the decrease in prices of stocks, crypto, or indices. If the fall is detected to be around 20% or more than that from the all-time high over the two months, then the market is considered bearish.
This bearish condition is susceptible enough to create a trap for novice traders. Seasoned traders keep know-how of the market indices and purchase the currency when the market is down. This time is marked as a point when most investors want to buy the assets at low prices but hardly find any sellers.
After bringing the market down, influential traders buy back the quantities sold at these low rates. Those traders with short positions would rush to buy crypto to limit their losses. This buying momentum results in taking the price even higher.
Therefore, by selling at a higher price and buying back all sold positions at a relevantly lower price, the trader group or bear trap setters’ intent is to profit from the difference without affecting the quantity of crypto held by them in the long term.
Difference between bear trap and short-selling
Bear trap and short selling are not the same things. These are two different terms. A bear trap includes short selling a stock or other crypto investment security. But, a decrease in price triggers a bearish investor on a short scale.
The investors do this to profit if the price continues to fall. But this is a quick reversal and rapid price increase that results in short-sellers facing a great loss.
We can understand the difference between a bear trap and short-selling by understanding that a bear is a trader or an investor who plays in the financial markets and believes that the security price is about to fall.
A bearish investment strategy gains profit from the decrease in the price of an asset, and a short position is used to implement this strategy.
A short position is a trading technique that borrows shares or contracts of an asset. This trader or an investor sells those borrowed instruments to buy them back when the price declines, thereby booking many profits.
Short sellers are bound to cover positions as prices increase to lessen losses. This increase in buying activity results in a further increase, which can continue to fuel price momentum.
Therefore, a bear trap is preceded by short-selling crypto by many investors who possess large token holdings and ends when they either close their derivative positions, buy back their shortly sold crypto positions, or a combination of both.
Is a bear trap bullish or bearish?
Considering both the increase and decline of the market, a bear trap can be traded by both the bullish and bearish traders by using markedly effective trading strategies.
Sometimes, a bear trap unsettles traders and market participants, as it includes the underlying asset undergoing a change in the momentum that is contrary to the bullish trend before quickly reversing again, to restart its upward journey.
If the asset’s price moves beyond the current resistance level, it can be a great sign and may be considered a buying signal by a bullish trader. Contrarily, bullish traders may employ a strategy that simultaneously sells calls and puts of key price levels to gain a wide range of profit.
Identifying bear trading
Bear trading can be identified usually by many indicators and analysis tools such as Fibonacci levels, RSI, and volume indicators and they are usually to confirm if the trend reversal after a period of consistent upward price movement is genuine or merely meant to invite shorts.
Avoiding a bear trap
- Start a Bigger stop loss.
- Avoid Trading the initial breakout, and instead, go for the retracement
- Start following the bigger trend
- Pay heed to the two candlesticks following the breakout
- Use technical analysis and trading indicators
- Checking the news
A bear trap is temporary, but a decline in the market occurs after a long-term rise which is quickly followed by a sharp rally of the stock or crypto. Big market players such as influencers and investors take benefit from this strategy.
It is usually suggested to avoid trading during these unstable and abrupt reversals until and unless price and volume action confirms a trend reversal below an important support level. It makes sense to retain crypto holdings during these times and avoid trading unless prices become stable or at the stop-loss level.
Exercising such things can be more difficult sometimes, especially when one factor in the high volatility is associated with most crypto in trade today. So, It is better to avoid trading during the bear trap for long-term investors looking for profit without high risks.
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