Trading, as we know it, is something unpredictable and shocking at times. When you anticipate that this situation will happen, the next thing you know, the opposite happens. Unfortunately, this is not uncommon. For instance, a bear trap is a technical pattern that shows up when the performance of a financial instrument like stocks or an index gives a wrong signal about the reversal of an increasing price trend. Furthermore, bear traps are fake reversals of a decreasing price trend. Hence, some investors lose a great deal of money when they fall into this trap. They may take long positions because they think that a price movement will happen when it will not.
Tell me more about bear traps.
So, you are wondering what happens behind these fake reversals. There are situations when there are way too many investors that are looking for stocks to buy. However, sellers are not interested in the bids that investors are giving. So here is what the buyers will do: increase their bids. When we say “bids,” we refer to the amount that a person is willing to pay for a particular stock. With increased bids, more sellers will be interested in selling their financial instruments. Hence, there will be an imbalance between the buying and selling pressure that will move the market higher.
Acquiring those stocks means selling pressure. Selling is the only way that can give investors some returns. A massive amount of people buying the said stock will decrease the buying pressure and increase the chances of selling pressure. Now, here comes the interesting part. Institutions tend to push the prices lower to make the markets look bearish and increase demand and stock prices. If an investor is a beginner, the chances of him selling the stock are high. When the stock drops, demand and stock price will increase because investors jump back into the market.
Investors and bear traps
Market participants can also tend to make a short position on an asset because of a bear trap. Why? They can make the market participants believe and expect that there will be a value decline in a financial instrument. But in the end, the asset does not decline but stays flat instead, leaving the market participants with a significant loss.
Let us look at another bear trap example. Bearish traders may short assets to repurchase them when the price drops at a specific level, while bullish traders may sell the declining asset to keep the profits. If the trend did not decline as expected or declined too late, it is nothing but a bear trap.
How can I avoid these traps?
Technical analysis and tools are some ways to avoid these traps. Suppose a trader wants to be extra careful. In that case, he will opt to use different tools like Fibonacci retracements, volume indicators, or relative strength oscillators to make sure that he does not make the mistake of falling into the traps. Many technical patterns help in market analysis and creating strategies. Also, many tools can help a trader in confirming the legitimacy of a security’s current price.