Bull Trap – Best Strategies to Trade Bull Traps
In other words,
therefore, price breaks the resistance and breakout traders jump in with their buy orders and push the price even higher. furthermore, sellers or bears which have many sell orders cause the price to drop and trap traders who had long positions.
many retail traders tend to look for trading opportunities which have a good profit in a short period of time, and this mindset causes them to be the first victims of
breakout trading profitability declined with the introduction of AI and particularly quantitative trading bots in recent years. usually, these bots can easily see the depth of market orders and trap traders in main resistance levels which cause bull traps.
Bull Trap Price Action
In general, we can consider 6 stages for a typical bull trap pattern or price action.
These stages could have a few changes in different bull trap situations.
In fact importance of the resistance level (e.g. Pivot point, Moving averages, Horizontal resistance lines, weekly or monthly highs/lows, etc.) and price action itself can change the bull trap characteristics.
- Price goes up, and when it reached the resistance level, it will break the resistance and move above it a little bit.
- Then breakout traders start to put market orders to help the price go higher.
- So bears sell limit orders will be filled and because of lack of bullish momentum, the price quickly stops moving higher
- Further, some of the breakout traders panic and close their long positions.
- Also, many of them open short positions to compensate for their losses and cause the price to go lower.
- Finally, when the price reached to swing low which many buyers put their stop losses, the price will hit their stop losses and shoot the price even lower.
Bull Trap Patterns
Some traders going to tell you there are bull trap patterns which you can easily identify them. But in reality, a bull trap pattern is a price pattern that is usually recognized in hindsight.
Also, these bull trap patterns have some differences in each market (Stock, Forex, Cryptocurrency, etc.).
Moreover, bull trap patterns are subjective and heavily depend on which time frame you’re analyzing them.
in the below example we depicted various types of bull trap patterns.
Example: Bull Trap Pattern in Forex
We analyzed British Pound/Dollar (GBP/USD) daily chart in the Forex market to describe different types of bull trap patterns.
In this chart, we had a weekly pivot point which was a major resistance line. So let’s see what happened:
- Price got rejected by bears and it closed below the resistance line. Also, the next candle couldn’t close above the resistance line and caused the price to go lower.
- This candle didn’t go above the resistance line and got rejected exactly on there
- Actually, this candle didn’t have a bull trap pattern and it couldn’t even reach to the resistance line.
- This bull trap pattern is so tricky, although the first candle closed above the resistance line,
butthe next candle got rejected by bears and price dropped sharply after that.
The last case was a perfect example of why you should
Always use other indicators like volume indicators to confirm breakouts and wait for a while to make sure it’s not a fakeout.
How to Avoid Bull Trap
Every problem has some solutions and bull trap is not an exception.
in order to avoid bull traps and mitigate your risks whenever you’re trading breakouts, you should consider these bull trap trading tips.
1. Using a Tight Stop-Loss
Using a tight stop-loss helps you to prevent big capital loss in breakout trading. You should put a stop-loss after opening your long position or have a mental stop-loss to use when it’s needed.
Putting a stop-loss order in these trades have a little more risk. Because stop-loss hunters usually know where a majority of traders put their stop losses. So they’ll usually cause the price to drop quickly and hit those stop losses.
Therefore, it’s better to have a mental stop-loss and use it when you found out that the trend is not bullish anymore and the price is going to fall soon.
2. Learning Technical Analysis Patterns
learning technical analysis and chart patterns helps you to identify some trading setups with high success probability.
e.g. in an ascending triangle chart pattern, there is a high probability that price would break the resistance line and go higher.
So if you know these bullish chart patterns, it will help you to understand the situation better and tailor your expectations toward opening a long position near a resistance line.
3. Proper Risk Management
trading breakouts have its own risk, and we mentioned some of them in the above sections.
In order to prevent from a bull trap and big capital losses, you should use a proper position size and never open a position with your whole account capital at once.
A trade’s position size depends on your risk tolerance and market you’re trading on. As a general rule, it’s better not to risk over 2-5 % of your capital in one trade.
Moreover, you can ladder your position to mitigate your risk. e.g., you can buy 50% before resistance level and buy the remaining 50% after the breakout to decrease your losses.
finally, never open a highly leveraged position in hope for quick profit in these trading setups, because price can easily turn
4. Understanding Market Sentiment
no matter what market (e.g., Forex, Stock,
one of the most important skills for a trader is understanding a market sentiment, and whether the overall trend is changing from bullish to bearish or not.
In fact, bull traps usually happen more in bear markets, because in these conditions there is not enough buying volume to cause the price breaks the resistance line and go higher.
5. Using Volume Indicators Like OBV
Volume indicators are very useful for identifying fakeouts and bull traps.
bull traps usually happen quickly, and they have low volumes, So the price goes up suddenly with relatively low volume then after a few minutes/seconds falls again sharply.
in OBV (On Balance Volume) indicator article we explained how you can trade breakouts in details with highe win rate.
6. Buying The Pullback
If you’re a position trader or swing trader and not a day trader, then you have a clear choice and it’s simply buying the price pullback.
this technique is mostly used by professional traders to prevent bull traps.
Instead of opening a long position near a resistance zone, you should wait till price pass that resistance and then put your buy order after it retraced to a proper support level.
As we showed in the above image, two bull traps happened before price could pass through resistance area.
Whenever price passes a resistance, that resistance becomes support for further moves. Therefore, Pro traders wait for the price to retrace to the new support zone and then fill their buy orders.
Bull Trap and Liquidity Pools
One of the most useful concepts regard to bull trap is liquidity pools.
If you want to fill a big sell order in a certain price, you need lots of buyers to buy from you. So, you should generate a fake demand in that price area and trap buyers there.
When big players want to fill their orders in important price levels, they usually push the price a little bit in the opposite direction to generate fake demand.
Actually, the bull trap happens exactly in these situations. in the below example we’ll explain liquidity pools in details.
Bull Trap and Liquidity Pool Example (Ethereum Chart)
In below image, we represented Ethereum chart (ETH/USD) on the 1h time frame. Ethereum was on an ascending channel, but then price started ranging and made a descending triangle.
two small bull traps happened first and finally, the big one which was a liquidity pool for bears occurred.
in this case study big players wanted to short Ethereum and fill their sell orders at the best price in end of the descending triangle.
So in order to do that, They pushed price a little bit higher to broke triangle resistance line and then trapped buyers with their big sell orders.
finally price reached to bottom of the ascending channel which was aligned with bottom of the descending triangle, and caused price to drop sharply.
How To Trade Bull Traps
I guess after reading the above sections you realized the best way to trade bull trap is not to trade it at all !
Maybe that’s not a bad decision, because to be a profitable trader you need to change your mindset from chasing short term setups with high risks to looking for long term opportunities with lower risks.
In other words, knowing bull traps help you to make better trading decisions and prevents you from falling to traps every novice trader do.
Bull Trap vs. Dead Cat Bounce
During a bear market or continuation of a downtrend, there are always some short-lived price recoveries which called dead cat bounces.
When price temporarily rises after a massive downtrend, buyers usually think this is the bottom and quickly jump on to fill their buy orders. but short sellers or bears, trap them in the key resistance levels and push the price even lower.
Another name of the Dead cat bounce is sucker rally, and it refers to naive investors or buyers who think the bear market is over.
In fact, a bull trap can occur everywhere, but a dead cat bounce always happens during a downtrend.
We represented the difference of a bull trap and a dead cat bounce in the below image.
In the above image, we analyzed the bitcoin price on the daily time frame. After price broke the bottom of the descending triangle, it dropped sharply.
Then a short price recovery happened, and some traders thought this is the bottom. However, the price got rejected by bears and went even lower.
Moreover, the price rose again to pass that resistance area, but short sellers trap buyers there again. So, the second and third attempts were bull traps and not a dead cat bounce.