Have you ever experienced trading when you feel like the price will break out then suddenly resumed its downtrend? Or when the price “feels” like it will slide down yet it powers on? This might be the case of a bull trap and a bear trap.
What is a bull trap?
A bull trap is a phenomenon when price rises above resistance level, only to resume its downtrend.
In the below example, notice how price tries to pierce the resistance level — which is seemingly a breakout — only to resume its downtrend later.
Notice how price tries to “fake out” twice: Fake-out #1 and Fake-out #2.
In both fake-outs, price is already outside the flag pattern / rectangle pattern / Darvas Box. Notice how price is even above midpoint or 50% of the rectangle or box (seemingly luring traders that this is a valid upturn).
What is a bear trap?
You were able to spot a perfect pattern to short. Price did breakdown from a rectangle or Darvas Box. Only to see price going back up and even doing an upturn!
This might be a situation called bear trap. Interestingly, “initial” price would make you right: Price did break down. Your trade was doing well. Until price goes back to your original short entry.
A bear trap is a phenomenon when price goes down the support level, only to resume its uptrend.
Let’s take a look at this example. Notice how $EURNZD tries to “trap” bears upon breakdown from green box, only to find a higher low and even turned bullish! In all fairness, as what was mentioned, price did breakdown and your short entry must have been correct. Only until price went back up that your short entry should have been turned into a long one!
Why do these traps occur?
In a separate Learning Module, we have covered various theories why these traps happen.
While these are all theories, remember that everyone around the world is looking at one, same chart. Everyone around the world is trading same risk assets, know similar strategies and are varying in terms of experience, capital and expertise.
In general, traps happen because markets get smarter, faster with technology and richer as more and more means are discovered to trade at most optimum way possible.
How to handle these traps?
Let’s take a look again at what happened to our first example:
Price tried to peak out twice, even breaking out of rectangle or Darvas Box. Eventually, price revisited support level of the pattern and broke down.
Where to put your stop loss?
In this case, if you were “long” at the breakout of the box looking for an upside, your stop loss can be placed just below the breakout level or upper line of the box). Other traders may choose to put stop loss below the 50% midpoint of the box. While some others are looking for a break of the lower line or support line of box (green circle) for stop loss level. In essence, your green circle is actually your breakout point for a “short” entry.
Remember that rectangle patterns and Darvax boxes are meant to be traded either as a breakout (upturn) or breakdown (downturn).
Specific Trading Setups
We have dedicated a separate Learning Module called Tricky Plays to guide us how to spot bull traps and bear traps in the forms of fake-outs, gaps and short squeezes.
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