What is bull trap? (Part 2)
Why does a bull trap happen?
From a psychological point of view, a bull trap occurs when buyers are unable to support the uptrend with strength after the break of the upward resistance zone. This inability to support the trend may be due to a reduction in the size and strength of the price movement.
Sellers, meanwhile, take advantage of the opportunity to sell their assets when they see a divergence.The price pulls back to the previous resistance and breaks it downwards, and this causes the buyers’ loss limit to be activated and the price to fall sharply.
What to do in dealing with bull traps?
The best way to deal with bull traps is to recognize the warning signs before they happen.As mentioned, declining trading volume is one of these symptoms. In such a situation where there is a possibility of a bull trap, the trader should withdraw from the trade as soon as possible.
In such cases, setting a loss limit in an exchange can be useful, especially in situations where the market can make emotional decisions.
An example of a bull trap:
In this example, during a severe sell-off, the stock price falls rapidly, recording a new annual price floor. Then the price recovers quickly and breaks the resistance area of the trend line upwards.
Many traders and investors buy assets with the prediction that the resistance is gone. But the price immediately fell sharply and continued its downward trend.
Buyers who have taken a long position in the previous two candlesticks will suffer heavy losses unless they have implemented risk management techniques.
To avoid getting caught in a trap, the trader must wait for strong confirmations and after getting these confirmations, enter the trade or set a loss limit very close to the support line and slightly below this line.