Treading the field of cryptocurrency is similar to other capital markets like forex and stocks — they are full of traps. The emotional, unknowledgeable, and unsuspecting trader can easily fall prey to any of the most common traps there are — bull traps and bear traps.
A bear trap occurs when a technical pattern in the crypto charts falsely reverses the signal of an uptrend. The rapid price decline is a trap to lure investors into taking short positions in anticipation of price movements after a key support has been broken. The expected price usually does not happen. After the trap, the price goes back to the uptrend leaving the bear traders at the losing end of a bad trade.
When A Bear Trap Goes to Work
A bear trap can entice a market player to anticipate a decline in value of an asset, which then executes a short position on the said financial instrument. But when the value remains flat, the player is in for a loss. While a bull trader sells a declining value for gains, a bear investor positions a short on the value and buys it back after the value drops to an ideal price level. When the expected downward trend does not happen or shoots back up after a short time, a bear trap has occurred.
Market players, in general, read technical patterns in analyzing market trends and evaluating investment strategies. Their analytical tools to map out bear traps include Fibonacci retracements, relative strength oscillators, and volume indicators. These are valuable instruments in aiding traders to understand or predict price trends in their legitimacy and sustainability.
Bear traders and investors speculate that the price of an asset or security is on the verge of declining. They believe that the direction of the market overall is on the downtrend. Bears then strategize by executing a short position to profit from the decrease. To implement a short position, traders need to borrow shares or contracts of an asset value from brokers via a margin account. The trader then sells off the borrowed shares intending to buy them back after the price drop, thereby earning a profit thereof. It is when bearish traders mistakenly identify the rapid decline without the necessary tools and knowledge; they run the risk of falling into the bear trap. Short sellers are forced to cover positions during the uptrend to control losses. Their buys will push prices to rise and will only slow down when short sellers have covered their short positions. It is important to execute stop-losses when placing market orders in order to minimize the damage from traps.
The opposite of a bear trap but the same in intention, a bull trap is the sudden price surge from a downtrend. It provides a false signal of price reversal made to lure emotional investors into executing long positions on a financial instrument. After falsely speculating and implementing a long position, the price drops, and the bull traders are trapped. Bull traps can happen when bull traders failed to support rallies above breakout levels for lack of momentum or profit-taking. If bear investors notice these, they will quickly grab the opportunity to sell the asset that will eventually drop prices below resistance levels, triggering stop-loss orders.
Ways To Avoid Bull Traps and Bear Traps
A price reversal needs a large volume in order to effect a real one. A sudden price reversal without a significant amount of volume to back it is a highly probable trap.
Check RSI Divergence
RSI, or relative strength indicator (oscillator), precedes any bear or bull traps. It is a momentum indicator that records the weakness and strength of a security price.
Check The News
Good or bad news in everyday headlines can trigger emotions enough to affect irrational trading choices of inexperienced investors. Market controllers can dictate bull or bear traps by using the news that are so often effective in catching traders off-balanced.
Use Stop-Loss Orders
Any trader for that matter, whether newbies or veterans, should sparingly make use of the stop-loss strategy. Given the high volatility of the cryptocurrency market, it is no respecter of any confident trader. It is imperative that a strict loss allowance must be set to close a position if and ever the trade goes bad. Considering a 1% to 2% of elbow room loss allowance based on your trading capital is wise.
Learning cannot stop when it comes to cryptocurrency investing. Delving into the market charts to let your eyes familiarize market movements are crucial in identifying potential bull and bear traps. Understanding analytic tools and utilizing them to maximize strategies to sharpen the mindset take you to winning ways in achieving your financial goals in cryptocurrency.
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