What is a bull trap and how does it work?

A bull trap is a reversal from an upward rally. Learn more about bull traps consisting of how to identify them and how to escape them, with examples, in this short article.

What is a bull trap?

A bull trap is a reversal versus a bullish trend that forces long traders to desert their positions in the face of increasing losses. It is called a trap since it typically catches traders off-guard, and comes on the back of a strong market rally that looked most likely to continue.

Bull traps are characterised by a trader or investor purchasing a property as it breaks through a traditionally high level of resistance. Many breakouts above resistance are followed by increasingly greater highs, however a bull trap is characterised by a bearish turnaround not long after the breakout.

How to determine a bull trap

It's tough to recognize a bull trap since normally after a breakout, an asset would be most likely to increase in cost, not reverse. However, what you can do is carry out technical analysis and fundamental analysis on the property you wish to trade.

Search for whether the possession is presently overbought, which might show a bearish turnaround from the prevailing bullish pattern. You might likewise wait prior to opening long position following a breakout, to see if the bullish pattern continues.

A popular technical indication to identify overbought assets is the relative strength index (RSI). 

Bull trap example 

In the below example, we've taken a look at the FTSE 100's cost motions. As you can see, it was moving in a fairly steady upward trend, with two peaks before realising a breakout above the historic high for this time duration.

Typically, we might expect this breakout to lead to a series of higher highs as the level of resistance has been breached. In this particular example, the breakout was actually a bear trap If a trader had actually opened a long position soon after the breakout, they would've rapidly found themselves faced by a bearish turnaround versus the prevailing pattern.

How to get away a bull trap

The best method to escape a bull trap is set a stop-loss on your position as you open it. This will assist you to prevent heavy losses if you're caught out by a bull trap.

There are a couple of sort of stop-losses to pick from, consisting of standard, tracking or ensured. When trying to prevent a bull trap, a routing stop would probably help you the most, due to the fact that it will trail behind the existing market value by a set amount of points, and it will immediately close your position if the market worth falls by that set quantity.

This will help you to secure as much revenue as possible, while likewise cutting losses early on into a bull trap.

How to trade a bull trap

You can trade a bull trap by opening a short position when you recognize that a bear trap is in effect. You can go short with monetary derivatives like spread bets and CFDs. These allow you to take a position on a possession without having to straight own it, making them well-suited to shorting.

Bull trap trading summarized

• A bull trap is a reversal from an upward trend shortly after an asset breaks through a historical level of resistance

• Usually, a breakout above resistance might indicate that the dominating trend will continue however this isn't the case in a bull trap

• Traders might take a breakout above resistance as a signal to go long and purchase the underlying market

• If this is the case, bear traps could lead to a trader losing cash as the cost falls after opening a long position

• Stop-losses-- especially routing stops-- can help you to prevent bear traps and their unfavorable results on earnings in your trading