If you are involved in crypto trading, you must know a few things to look out for. The crypto market is as complex as it is interesting and for any trader, there are certain pitfalls you should avoid to make the most of your investment. Some of these are bear and bull traps.
Bear and bull traps exist in the traditional asset market as well as the crypto market. These traps have seen many investors make unwise trading decisions that affect their bottom line. But what are bear and bull traps and how can you avoid falling for them? We break it down in this guide.
Bear Trap in Trading
A bear trap in the trading world is a situation in which an asset initially appears to be trading upwards in terms of price. Then, the asset loses some of its value and it appears that it is about to go into a decline i.e. enter a bear market. As traders see these market indications, they try to respond in time, which usually involves opening short positions.
A short position involves traders borrowing shares of an asset from a broker using a margin account. The idea is to sell these instruments and then repurchase them when the price drops and make a profit. A bear trader believes that an asset or the market as a whole is about to go into a decline and tries to profit from it. This involves leveraging strategies like short positions to make this happen. But as we’ve said, a bear trap is just that; a trap. The decline does not last and soon after, the price of the asset rises again after bear traders have been ‘tricked’ into taking short positions.
Bear traps exist in virtually every asset market and traders put a lot of time and effort into avoiding falling victim to them.
Bull Trap Explained
A bull trap works similarly to a bear trap but in reverse. This happens when an asset increases in value and breaks above a certain resistance point. Usually, breaking above major resistance points could signal that an asset is about to enter a bull run and become more valuable. As such, many traders decide to open long positions to profit from the price movement.
The idea is that if they can buy the asset when its price is starting to rise, they can later resell it for a profit. A bear trader, in this case, is trying to take advantage of the upward price movements of an asset.
But just like with a bear trap, a bull trap sees the asset’s value experience a reversal shortly after breaking key resistance points. The bear trader who would have hoped to resell the asset at a profit now finds themselves with an asset that is fast losing its value.
These bull traps exist in virtually every asset market and concur for many reasons. They could be due to traders losing momentum after breaking resistance barriers which leads to many selling off their assets, as well as further selloffs triggered by stop-loss orders.
Bear and Bull Traps in Crypto
As we have mentioned, bear and bull traps exist in virtually every asset market and the crypto sector is not exempt. Many cryptos experience both and they manifest in rather unique ways. Take altcoins that see sudden hype within the industry and have their value increase in a short time. This is commonly seen in tokens tied to specific events like the cryptos released after the death of Queen Elizabeth the Second. Many crypto investors might buy into these tokens expecting their value to keep increasing. But, for whatever reason, the tokens begin to decline in price and the trader sees that plan fall apart. This would be an example of a bull trap.
A bear trap would involve a crypto that appears to be on the decline. Perhaps it is a token that has seen several swings, with some investors planning to purchase it at a lower price and resell it for a profit. But then, the value of the token goes up, putting them in an awkward position. Because of the volatility of the crypto market, both bull and bear traps are fairly common and can be caused by trends in the industry, the activity of whales, media reports regarding the asset, and so on.
Role of Psychology in Bear and Bull Traps
One thing that is important to know about bull and bear traps is that they are both triggered by psychology. First, there is the unidirectional attitude that many investors have towards the market. This means that they consider themselves bull traders or bear traders and only train themselves to operate in one of these conditions. As such, they are more prone to fall into bear or bull traps because they are only chasing one market movement and are not flexible enough to operate in whatever the market throws at them.
Besides, there is the classic fear of missing out (FOMO) which makes investors panic at the thought of not immediately profiting from a market movement. So, rather than wait and properly observe the progression of the market, they act immediately and get caught in traps.
Crypto Bear and Bull Traps: Examples
We’ve already established that bull and bear traps are common within the crypto industry and there are several examples of these. For instance, take SOL, the native token of the Solana ecosystem. In the first week of June 2023, the token had seen a decline of about 42% and seemed to be in a freefall. Then, the token began to rally in the next week, hitting key resistance points of around $15. All the expectations of the token continuing to decline were dashed and traders who had opened short positions were disappointed.
Then there is Bitcoin (BTC) which has seen several bull traps over the years. In both April and August 2021, Bitcoin saw a price dip after it had been consistently rising for a while. In April of that year, Bitcoin crossed the $54,000 mark, only to decline by over 17% shortly after.
Identifying and Avoiding Bear and Bull Traps
Now that you understand what bull and bear traps are, you should know how to spot and avoid them to get the best trading experience possible.
To spot and avoid a bear trap consider the following:
- Look at key indicators. When considering opening a short position for an asset look into its Fibonacci levels and relative strength index (RSI) divergence. An asset that doesn’t close below critical Fibonacci levels could be a sign of a bear trap.
- Consider key resistance levels. One of the tell-tale signs of a bear trap is the asset’s price experiencing a reversal after a key resistance point. If the asset in question just reached a new all-time high or crossed a major milestone, be aware if it appears to be trending in the opposite direction.
- Low volumes. Always look into what the current trading volumes are for the asset. If its volumes are low, it is best to be wary.
To spot and avoid a bull trap consider the following:
- Key indicators. Just like with a bear trap, looking at things like RSI divergence. A high RSI indicates heavy buying pressure which means that the current price increase might not last.
- Trading volumes. As in the case of bear traps, low trading volumes could mean that the price movement is due to the activity of a few whales and is not sustainable.
- Resistance levels. Another sign of a bull trap is an asset initially seeing a lot of momentum but is unable to cross certain resistance levels. This usually indicates a bull trap in the works.
Trading any asset, especially one as complex as cryptocurrency, will never be without its road bumps. Some of the things to look out for are bear and bull traps, which can put any investor in an uncomfortable position. Bear and bull traps have investors thinking they know the trajectory of the market and acting accordingly, only to get bamboozled.
For any investor, it is important to study the market and learn how to identify bear and bull traps so that if and when they take place, you won’t be caught unawares.