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What is a bull trap and how do I avoid it?

It takes practice to trade or avoid bull traps, just like any other chart pattern or trading strategy. In this article, you’ll learn what to watch out for, why bull traps happen, with examples and how to take advantage of them. A bull trap can occur in stocks, or any other asset class, on any chart time frame.

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What is a bull trap?

A bull trap can occur when the price of an asset rises above a resistance level​, luring in more buyers as they chase the upside breakout. The buying tends to be short-lived, though, and the price may tumble shortly after. It’s called a trap because those ‘bulls’ who bought in as the price was breaking out to new highs must exit or face mounting losses as the price reverses course and declines. Bull traps can be costly for those who get caught but potentially profitable for those who understand what is happening and use this knowledge to trade them.

Bull traps tend to occur in downtrends or bear markets​ when prices start to rise. Buyers may view the rise as a possible end to the downtrend. A technical signal, such as the price moving above a resistance level, may help to increase that confidence. These buyers could jump in but then quickly become overwhelmed by sellers as the downtrend continues.

While bull traps are typically associated with short-term price rises within a downtrend, a bull trap can also occur in a flat market or near the end of an uptrend.

When the price of the asset moves sideways, periodically, it may attempt to move higher, breaking above the prior high of the price range. If there aren’t enough buyers to keep pushing the price higher, the price may tumble back into the range, trapping those who just bought into a losing trade.

The same thing can happen at the end of an uptrend. As the number of buyers dwindles, the price may push slightly above a prior high point – the trap – only to fall sharply because sellers are becoming more dominant.

Bull traps can occur in any financial market, including stocks, indices, or forex trading.

What role does psychology play in bull traps?

Psychology is a key component in bull traps.

First, there is often a desire on the part of buyers to enter a trade at the first sign of a price rise. This may make these traders more susceptible to getting ‘trapped’ because there is little evidence of an actual sustainable move to the upside. They are buying with a bit of evidence – the price moving above resistance – but they are mostly buying based on hope as the breakout turns out to be fake.

Psychology also comes into play when those buyers realise there are no other buyers coming in after them. As selling begins, the traders who just bought may panic and sell, further driving the price down.

Price action​ is simply the manifestation of people’s bullish and bearish actions. While some of these actions are based on well-researched strategies, statistics and experience, price action may also be the result of people taking trades based on fear of missing out (FOMO), greed, anxiety, and other emotions.

How do you identify a bull trap?

While bull traps can vary in how they look, these types of traps can have common technical signs, such as:

  1. A downtrend, a weak uptrend, or the price is moving sideways.
  2. The price moves above a prior high point in price or above a resistance level.
  3. The price is above the prior high or resistance level only briefly.
  4. The price then falls back below the prior high or resistance.
  5. Those who bought may wish to sell or they might face larger losses.
  6. Because there was little to be bullish about in the first place, more experienced traders may take the elevated price as an opportunity to sell. This helps to drive the price lower.
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Examples of bull traps

The gold chart below shows an example of a bull trap:

As you can infer, the price was rising but then experienced a sharp decline followed by a series of lower swing highs (descending red line).

A resistance level forms as the price moves sideways for about one month (blue line).

The price spikes above the resistance line, which may attract buyers who are hoping this is the end of the downtrend. However, it isn’t. The price quickly falls, creating a bull trap and the downtrend resumes.

Below is another example of a bull trap in a EUR/USD chart.

In the chart, the currency pair has entered a downtrend, which is shown by a series of lower swing lows and lower swing highs. But then the price moves above a prior swing high, drawing the downtrend into question. Those looking to buy may choose to jump in, but the rise quickly fails, and the downtrend continues.

To identify a bull trap, traders could watch for a bearish candlestick chart pattern​ just above the resistance area. A bearish candlestick pattern could indicate that buying momentum has slowed, and selling pressure is coming in. For example, the ‘shooting star’ candlestick pattern helped set the stage for the price decline on the EUR/USD chart.

How do you trade a bull trap?

The lesson of the bull trap is that buying at the very first sign of a possible new uptrend can be dangerous. Many of these attempted moves higher may fail because there is little overall buying pressure to begin with.

When a position turns out to be a losing trade, some traders can make emotional trading decisions that move prices sharply. This phenomenon is known as ‘trapped traders’ and can be used to profit in some circumstances.

Therefore, you may consider watching for bull traps as the price moves above a resistance level or prior swing high within a downtrend and consider taking a short position if the price starts dropping below the resistance level or prior swing high.

Here are some possible steps that you could follow.

  1. Open a demo account or to practise trading on bull traps within the financial markets. This is possible via spread betting and contracts for difference (CFD).
  2. Use our product library to pull up charts of assets and find one that is in a downtreUse our product library to pull up charts of assets and find one that is in a downtrend.
  3. Identify a resistance line on the chart by marking the top of a price range or recent swing highs. You can use our extensive range of draw tools to do this.
  4. Wait for the price to move above the resistance level or swing high.
  5. You may consider entering a short trade if the price falls back below the resistance level, as the move higher was a false signal. There are additional tools that can be used for confirmation, such as technical indicators or candlestick patterns.
  6. It may be a good idea to place a stop-loss order above the recent high to control risk in the event that the price continues moving higher.
  7. Consider an exit plan if the trade is profitable. Exit strategies include setting a profit target or using a trailing stop-loss.

Bull trap vs bear trap: what’s the difference?

Whereas a bull trap traps buyers in a losing trade, a bear trap traps sellers or short sellers in a losing trade.

A bear trap typically occurs during an overall uptrend. The price of the asset may experience a short-term decline, dropping below a support level, enticing people to sell existing long positions or take short positions. If there are not enough sellers to keep the downward momentum going, buyers may step in and drive the price higher.

Those who shorted can become trapped in a losing trade and must buy to exit, and those who sold may experience regret for selling and wish to buy again, driving the price higher.

The following chart shows an example of a bear trap that occurred in our US SPX 500 instrument:

The following chart shows an example of a bear trap that occurred in our US SPX 500 instrument:

Triangle patterns may occur when the price of an asset moves within a smaller price area over time. This creates a triangle-like appearance on the chart. Traders may watch for breakouts from these patterns.

Rounded tops and bottoms signal the end up of an uptrend or downtrend, respectively. A rounded top occurs when the price ascent slows down, then starts moving sideways or makes very little progress to the upside, and then starts moving lower. A rounded bottom is similar and occurs after a decline. The rounded bottom looks like a saucer.

These chart patterns, and more, are covered in our guide to the 11 most essential stock chart patterns.

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FAQS

Bull trap vs dead cat bounce: what’s the difference?

A dead cat bounce is a general term for any upward price movement that occurs during a strong downtrend. A bull trap usually has technical elements involved, such as the price moving above a prior resistance level. This creates the trap. A dead cat bounce may exhibit similar characteristics to a bull trap. Learn more about support and resistance.

Is a bull trap bullish or bearish?

A bull trap is short-term bullish but longer-term bearish. The bull trap lures in buyers, creating a short-term rise in price. This eventually gives way to selling pressure and a falling price. Read about bear markets and bull markets.

How do you manage risk if caught in a bull trap?

To manage risk when trading in a bull trap, you may consider the use of stop-loss orders. This order will close out the trade if a certain amount of money is lost or a certain price is reached. Also, consider the position size. Larger position sizes carry greater risk and profit potential than smaller ones.

Disclaimer: CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although we are not specifically prevented from dealing before providing this material, we do not seek to take advantage of the material prior to its dissemination.

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