Everything you need to Know About Bear Trap
Have you faced situations that didn’t turn out to be as they seemed at first?
Well, you won’t be the only person who has faced a disappointment of this sort. In the stock market, a similar concept called the bear trap has perplexed and deceived many traders. While the bear trap is a trend that cannot be controlled by any market participants, it affects all of them, at least to some extent.
So now, let’s find out what a bear trap is and how it can affect trading.
What is Bear Trap in the Stock Market?
In the stock market, traders depend on technical indicators to help them trade effectively. While not an indicator, a bear trap is a technical trend or pattern that can be seen when the price movement of a stock or any financial security signals a false reversal from a downward to an upward trend.
It is a popularly used term in the market when the market indicates a downturn at first but quickly picks up and goes into steady growth. When the market starts turning bearish, it means there will be a drop in the stock prices. This is when traders sell short and then close their positions to avoid losses. However, in the case of a bear trap, the market does not indicate an actual downtrend, but only appears to do so. This concept is quite common during a market uptrend.
Also Read: Bear Market & How to invest in falling market?
How to Trade during a Bear Trap?
A bear trap market can prompt the trader to anticipate a drop in the stock price as a result of which they may sell short. However, the price stays flat or rallies, which means the trader will incur a loss. Short selling, also known as shorting, is when a trader sells high and buys the asset when the price is dropping to earn a profit.
Hence, if a trader is short selling, they can use a bear trap to their advantage. In a bear trap, traders can borrow stocks from their stockbroker on margin. However, short selling during a bear trap can come with increased risks.
When there is a rise in the price, instead of a drop, it is possible that you could be paying more when you buy back to uphold the margin. Therefore, in such a scenario, a trader could be looking at more risks than a bullish trader who takes a short position during a price drop.
To trade in a bear trap, it is important to identify when a bear trap occurs. Therefore, traders may rely on a combination of technical trading tools such as Fibonacci bands, volume indicators, Relative Strength Oscillator (RSI) and others. This helps them spot any sudden signs of reversal in an otherwise stable bullish market. They can then wait for the downtrend to pass instead of acting on it and checking other parameters to identify a bear trap.
A trader can also identify a bear trap market through the market volume. When share prices fluctuate significantly, the market volume will change accordingly to reflect the trend. Traders look out for a sudden indication of a price drop without any change in the volume to look out for a bear trap.
So, as you can see, a bear trap can be a tricky situation for most traders who may not be quite well-versed with the market and its varying trends. Therefore, if you happen to trade stocks and are faced with a bear trap, be sure to exercise caution and identify the trend with the help of technical tools before taking a call.
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Frequently Asked Questions
Traders use short selling to avoid losses when the market begins showing a downtrend. However, since a bear trap is only a false indication of a downtrend, short selling can lead the trader to incur losses since the market takes an unexpected turn.
A bear trap can be spotted if there is a sudden indication of a downtrend in a stable market. To confirm if it is a bear trap, the trader may use technical trading tools such as volume indicators, relative strength index (RSI), Fibonacci bands and also keep an eye on the market volume. However, it is possible to identify a bear trap in the stock market if you have been trading for quite a while.
A bear trap need not necessarily be a negative sign; it is a trend that needs to be identified, and the trader should be able to find their way through it. While there are certain risks of selling short in a bear trap, once identified, the trader can plan their next move wisely.