Definition of ‘Bull Trap’ - A bull trap is a false signal, referring to a declining trend in a stock, index, or other security that reverses after a convincing rally and breaks a prior support level.
What is a bull trap?
Bull Trap Definition - Bull traps are deceptive signals that show that a financial asset is experiencing a long-term downward trend. These assets could be cryptocurrencies, stock, or other forms of financial securities.
As an investor in digital assets or securities, there are certain phenomena you want to avoid — a bull trap (or “whipsaw pattern”) is one of them.
In a bull trap, a financial asset will show signs that its value is about to recover or experience a recovery, but it usually ends up declining even more. This is how it happens:
- The value of the asset goes above its support level prices in the past, and this makes traders see it as a great investment opportunity.
- For most of them, they either buy more of the financial asset or have new long positions.
- … And then the damage is done.
Bull traps are just one reminder of why proper analysis should be carried out before trading decisions are made. Because, sometimes, investors predict that a breakout will result in a better price rally which turns out negatively in the end. Analysis should be done by studying price patterns and looking out for signals on the price chart of that asset so that proper futuristic predictions could be made.
The history of bull traps
To help you understand the concept of bull traps more clearly, let’s myth-bust some of the mystery surrounding bull trapping in cryptocurrency.
Why is it called a bull trap?
The name ‘bull trap’ is far more on the nose than you’d imagine: essentially, it’s the bullish investor who tends to fall victim. A bullish investor may purchase a financial asset, expecting the asset to increase in value — but it’s greed or competitiveness that’s taken over, instead of smart analysis. And so, when the value of the asset keeps on plummeting, the investor ends up trapped; the charts having misled them into making the wrong decisions.
What causes a bull trap?
When the upward price movement of an asset is sustained for a period of time, this is known as a ‘bullish trend’.
It’s an indication that the market has been controlled by buyers who may at that moment be running short of resources.
Watch the activity closely, and you will notice the price hitting a resistance zone. Shorter candlesticks usually appear as prices slow down because, at this point, some buyers are already taking off their profit as the asset hits resistance.
And here’s where it gets really interesting. At the resistance level, trading activities generally reduce in intensity.
But then buyers get involved again and push prices above the resistance level or zone of resistance — this forms what is known in the market as a "break out."
Buyers who may not have engaged proper analysis before making decisions, or are not as experienced in the market, then execute more trades because they think they’re seeing a continuation of the uptrend.
By this time, the majority of buyers have depleted resources in their hands — and when the sellers notice this, they begin to flood the market with sell orders.
This is why sellers are said to control resistance zones. Buyers who can see what’s coming will jump at the chance and quickly end their trades. The sellers respond to the reducing number of buyers by sending in more sell orders. This makes the trend tilt in favor of sellers and, as it sinks even deeper, new buyers have their stop losses taken out.
Buyers who expected the trend to continue its upward movement are left wondering what happened (and quite a lot lighter in funds). Those who have no stops or have wider stops become stranded in a trend that has stopped working to their advantage.
How do you predict a bull trap?
Success in trading stocks, crypto, or any other financial assets comes down to a lot of analysis and a little bit of luck.
That is, with study and analysis of previous market circumstances, one can almost accurately predict what to expect. So what should you look out for to spot a bull trap trend?
Ridges formed at the resistance level which shows multiple testing: this happens when a bullish trend exists for a long time but slows when it gets to the resistance level — evidenced by shorter candlesticks. Some buyers will engage more of their resources until it breaks above the level a bit. But, most likely, a bull trap will happen next. \
A large bullish candlestick: this usually happens when buyers purchase the asset in large amounts because they believe a breakout has happened.
What is a bull trap in crypto?
A bull trap is a false increase in a coin’s value, followed shortly by a sharp decline. Three events categorize a bull trap in trading crypto: an initial dip, a short-lived rebound, then even a further dip. When a cryptocurrency experiencing a dip begins to witness an upward trend, investors become optimistic about its continued uptrend movement, engaging in more trades. This happens too frequently in the crypto market because of rapid recoveries, causing traders to buy crypto assets in haste, as they expect the value to rise.
What happens after a bull trap?
You don’t want to be involved in a bull trap if you can avoid it. Generally, there would be losses on the part of buyers who bought tokens when there was a rise in the trend movement. However, the next thing crypto traders do is to activate their stop losses.
How do you know if it's a bull or bear trap?
Like a bull trap, a bear trap is also a position crypto traders want to avoid. A bear trap happens when traders observe a downtrend and are afraid that the trend will continue its downward movement. This causes them to exit the market before prices reach the floor. Unexpectedly, though, the trend picks up again — making the token even more expensive than it was before the trader exited the market. This causes the trader to suffer loss or lose the opportunity to have sold at higher prices.