What is a bull trap and how to identify it?

1. Definition of bull trap in trading

In trading, a bull trap occurs when traders buy an asset thinking its price will continue to rise, only to see it fall significantly after reaching new highs.

Bull traps occur during periods of uncertainty in the market or when false information about a specific asset is circulating. It is called a "bull trap" because inexperienced traders are led to believe that an asset that is falling is actually rising. This false sense of security can lead to substantial losses.

When a bull trap is suspected, traders should exit the position immediately or establish a short position. Stop loss orders are very useful in these situations, especially if the market moves quickly, to avoid being carried away by emotions.

As with many aspects of trading, identifying bull traps can be tricky. However, the best way to avoid them is to pay attention to warning signs —such as breakouts with low volume— in advance.

2. Operation of bull traps

Bull traps can have serious consequences for those who buy during a perceived reversal.

Imagine you are analyzing the chart of an asset that is in a bearish trend. After some time, the price reaches a point where it starts to move sideways within what is called a "range".

During this period, bulls and bears are at war trying to push the price in opposite directions. Bears are trying to push the price to new lows, while bulls are trying to maintain the price upwards.

At some point, when the bears win, the price breaks below that range and falls to a new low. However, just when the bearish trend seemed about to resume, the bulls return and push the price back to the previous highs.

Many traders see this as a bullish reversal and start buying, thinking that the downtrend has ended. Unfortunately, this is often just a temporary move and prices quickly resume their downward trend, resulting in heavy losses for those who bought at or near the peak.

Meaning of a bull trap in the cryptocurrency market

Also known as "dead cat rally", bull traps frequently occur in cryptocurrencies due to rapid recoveries.

In cryptocurrencies, bull traps work the same way as in any other market. For example, if the price of an altcoin has been consistently rising over the past few days, you might think it will continue to rise. You buy some and hope the price goes up to sell for a profit.

However, on the contrary, you find yourself in a losing position. You witness a bearish trend and then expect a bullish reversal, at which point you may buy on the dip thinking you are acquiring an asset at a reasonable price. The trap manifests when the price pulls back and returns to the bearish trend.

The role of psychology in bull traps

The bulls chase and take advantage of the momentum, and everything goes well until the next bear market returns.

When this happens, they can fall into a bear trap and close their position at a loss. Investors used to trading in bullish markets may fall into the trap of buying high and selling low due to a strictly bearish or bullish one-way mindset (. Experts recommend having a two-way mindset to succeed in both bullish and bearish markets, as this allows for greater profits in long-term trends.

) Strategic use of bull traps

Bull traps are used by day traders and long-term investors to take advantage of unsuspecting market participants.

For day traders, a bull trap can be an opportunity to go short when a value bounces back to its previous highs. The price will then resume its bearish trend, generating profits for the trader.

For long-term investors, a bull trap can be an opportunity to buy an asset at a lower price during a correction after a rally. This way they can safely position themselves for the next bullish trend.

3. Causes of bull traps

Several factors lead to bull traps in the market, with one of the most common being the lack of buying in a rally towards previous highs.

A weak buying volume indicates that there is not much interest in a specific low-priced asset and that the bulls are not sufficient to push the price higher.

Another common cause of bull traps is false breakouts of consolidation patterns. The price breaks out of a range upward but then quickly retraces and resumes its bearish trend.

4. How to identify bull traps

The following are revealing signals to detect a bull trap:

RSI Divergence

A high RSI may indicate a potential bull trap or bear trap.

The calculation of the Relative Strength Index ###RSI( can be used to identify possible bull traps or bear traps. The RSI is a technical indicator that can help determine whether a cryptocurrency asset is overbought, oversold, or neither.

Typical calculations cover 14 days, but they can be applied to other time frames. This period does not affect the calculation because it is removed from the formula.

In the context of a possible bull trap, a high RSI and overbought conditions indicate increasing selling pressure. Traders are eager to secure their profits and are likely to close their positions at any moment. Therefore, the first breakout and bullish trend may not indicate continuous price increases.

) Insufficient volume increase

When a market breaks upward, the volume should increase significantly as more people buy while the price of the asset rises.

If there is little or no increase in volume during a breakout, it indicates that there is not much interest in the asset at that price and that the rally may not be sustainable.

Price increases without a significant rise in volume could also be due to bots and retail traders competing for position.

Lack of momentum

When an asset experiences a significant drop or gap with a huge red candle, but then rebounds very modestly, it indicates a bull trap.

The natural trend of the market is to move in cycles. When it reaches the peak of a cycle, it generally follows a period of consolidation while bulls and bears fight for control.

This lack of momentum can be seen as an early warning sign that the market is about to change direction.

Lack of trend breakout

A price decrease is represented by a series of lower lows and lower highs.

Price trends do not always change when an advance occurs. As long as the price does not rise above the recent lower highs, the bearish trend remains intact.

The lack of confirmation is one of the most common mistakes made by those who fall into bull traps. They should be suspicious since if the current high does not exceed the previous high, then it is in a bearish trend or in a range.

This is often considered "no man's land" and one of the worst places to start buying unless you have a good reason to do so.

Although some traders may feel disappointed by this, most are better off waiting for confirmation and buying at a higher price than trying to "get in early" and getting trapped.

Retest of resistance levels

The first sign of an imminent bull trap is a strong long-term bullish momentum, but with a quick reaction to specific resistance areas.

When an asset is in a strong bullish trend with little downward pressure, it means that buyers are pouring all their resources into it.

However, when they reach a resistance level that they are unwilling or afraid to break, the price often reverses before moving higher.

Suspectingly huge bullish candle

In the final stages of a trap, a massive bullish candle generally appears that takes up most of the candle immediately to the left.

This is often a last desperate effort by the bulls to take control of the market before the price reverses. It can also occur for several other reasons:

• Big players deliberately push prices up to attract unsuspecting buyers.
• New investors believe a breakout has occurred and are starting to buy again.
• Sellers deliberately allow buyers to dominate the market in the short term by allowing limit sell orders to be accepted above the resistance zone.

Range formation

The final characteristic of the bull trap pattern is that it creates a pattern similar to a range at the resistance level.

When the price of an asset moves within a certain range, it is said to bounce between support and resistance levels.

Due to the fact that the market may still be forming higher but smaller highs, the range may not be perfect, especially at the upper end. However, the start of the bull trap is visible as the large candle mentioned earlier forms and closes outside of this range.