Greeting traders and welcome back to another In Depth with Chris episode.
In today's discussion, we will be talking about the bear trap.
This is in fact the counterpart to the bull trap.
Neither one of these are good scenarios when you're caught
on the wrong side of the coin, but both of them can indeed
be traded. The bear trap is no different.
We're going to cover exactly what a bear trap is, as well
as how it can be traded, and we're going to cover examples
of exactly what it looks like, so you can ultimately spot them
in your trading and decide whether you want to engage them
or just simply avoid them entirely.
But before we go any further, if you could do me a favor and click
that like and subscribe button down below.
I'd really appreciate it, so I can you know,
keep these videos rolling out for you guys.
But without further ado, let's get going.
In trading, we have bull markets when the market is rising
and we have bear markets when the market is falling, but also
because of this, there is something called a bull trap and a bear trap.
Today, we'll be discussing the bear trap.
What exactly is a bear trap? A bear trap is a technical
pattern that commonly occurs when a stock or broader index
misleadingly reverses after trending upwards.
These bear traps can often trick and lure investors into
shorting because of that potential reversal before continuing
onwards, getting them caught in the trap.
It runs over the sellers and the market continues to stampede
upwards, and upwards, and upwards it goes.
Let's talk about how it works.
They work in a simple, yet complex way.
The bear traps prompt investors to expect a decline in the
price of whatever it is they're analyzing, which then in turn does cause the investors
themselves to go ahead and initiate those short positions
because they're expecting price to fall.
They're betting on the decline. When the asset that was shorted
stays flat or rallies, the investor unfortunately takes a loss.
While some investors sell a declining asset to keep the profits,
others may be more bearish and will continue to short the same declining asset
with the intention of profiting and buying it back
once the price declines to a certain level.
But if that trend downwards never happens or briefly reverses,
the price reversal is identified as what is called a bear trap.
The bear traps can be deliberately caused by a big
institutional investor trying to trick the smaller traders
into thinking that there's an opportunity to short. Once enough
short-sellers initiate positions,
they then lure you in and start going long, reversing price
momentum, and gobbling up your orders.
Bear traps can work in several ways, with two of the most common ways being a
support level bear trap and a volume level bear trap.
A support level bear trap happens when price hits a support level or
briefly breaks it then reverses upwards.
A volume level bear trap occurs the same exact way however,
based on volume, rather than support.
There are several ways to identify a bear trap.
Investors most commonly use technical patterns
to analyze and evaluate the market trends.
Tools such as the Fibonacci Retracement,
Relative Strength Index, and volume indicators alike,
all can aid investors' technical analysis and predicting the
sustainability of an upwards or downwards trend.
The Aroon indicator, which we can see down here on the bottom of the
chart, is a particularly popular technical indicator that
is used to identify price trends,
as well as the strength of those trends to help identify bear traps.
Aroon indicator strategies signal when there is a strong
uptrend or strong downtrend, and detect the legitimacy in trend changes.
The Aroon indicator is composed of two lines, as we can see.
The up-line measures the number of periods since a high and
the down line measures the number of periods since a low.
Typically, the Aroon itself analyzes 25 periods of data by default.
When the up line is above the down line, it indicates
bullish behavior. When the bearish price behavior is signaled,
we are usually going to see the Aroon the other way around
with the down line above the up line. When the lines cross
that means, usually, a new trend is starting. While moving average
tools, which use technical analysis of price changes,
the Aroon indicator is based on timing that compares the last high to the last low.
The Aroon indicator operates between a scale of 0 to 100.
For example, if the Aroon up is at 0, well then that means
the asset has not made a new high since the start of the period.
If the Aroon down is at 0, that then means that the
asset has not made a new low since the start of the period.
Usually investors focus on the 30 and 70 levels along that
scale from 0 to 100 because the 30 and 70 level show that
the last high or low occurred in the most recent third of
the time period being analyzed.
By paying attention to indicators like the Aroon, or just price action in general,
we can get an idea of how legitimate a move is by paying
attention to how recently and how actively the market is
continuously adding new highs or new lows in the market.
With this chart, we have the Dow Jones futures back from 2013, where we're
seeing a very clearly defined bull and bear trap for that matter.
On the left of the chart is 9:30 p.m.,
and that is 9:30 p.m. on August 8th,
and on the very right it is going to be 5:00 p.m. from August 9th.
This showcases how volatile the futures
markets can be by showcasing a bull trap and a bear trap on the same chart.
At the top in the red box, we have a bull trap. On the green box,
we have ourselves a bear trap. As the Dow moved lower from
the early morning hours of 6:15 a.m. to 8:45 a.m.,
those who bought the contract at the higher price levels
panicked and sold, while others tried to profit by dropping
it to a short position. While the abundance of sell orders
and shorts caused a sharp market drop, more buyers actually
entered the market than sellers, sharply reversing the market
and causing it to go higher. The market then rallied 104 points
from the lows of the day.
This chart represents a very recent example of a bear trap
involving oil back in April. As everyone probably remembers,
oil was arguably the most volatile commodity during the COVID
crashes of March and April.
Even briefly, it turned negative for a period of time. While many people
were profiting off of shorting the oil futures contracts,
many also lost a lot of money during the subsequent recovery.
If there was ever a perfect example of a bear trap, it would
be this chart of April 2020 futures contracts
for oil. While the futures contracts for oil move to negative prices,
let's pay attention to how volume actually ticked up significantly
when oil bottomed out. Before a stock or commodity starts
a reversal, volume will usually accelerate. But when the asset
changes direction and the volume is low, this could always
become a bear trap.
We want to pay attention to the overall direction and momentum
of an asset. For example, oil was already on a bearish decline.
But after oil bottomed out, once May rolled around, we witnessed
the oil prices jump by nearly 90%, which was the largest gain in history.
This chart of Twitter showcases a good example of a market
volume bear trap. When a stock is starting to reverse, approaching
new highs or new lows, the volume accelerates like we said.
But when the market changes directions and the volume is
low, this could always be a bear trap and we need to be on the lookout.
Notice how in both of these bear traps on the
chart, this stock has still some type of bullish trend defined
by the long black arrow.
Suddenly, the trend line is broken and the price begins to sharply decrease.
But notice the volume below on this chart.
Volume is relatively low, which shows that the reversal may not be
a truthful indicator of a reversing long-term trend.
The key takeaway if we're looking at volume, is to identify
if the volume substantiates the actual reversal. If it's reversing
and the volume is relatively low, chances are it's not going
to be powerful enough to reverse the entire longer-term trend.
While many believe that investing in a bear market is counter-intuitive,
bear markets offer significant opportunities for either buying
low or from profit generated from shorting.
Generally, a bear market is going to be classified as when
a stock or index falls by 20% from their most recent high.
Investors either find opportunities to go long on stocks
or indexes attractively priced and start buying, or
predict that the stocks will continue to go lower and open those shorts.
Depending on the amount of activity, either long or short, the markets
will either go lower, officially continuing the bear market,
or they'll go higher, officially starting the bear trap.
As we touched on before, investors can use multiple trading techniques
such as the Aroon indicator, Fibonacci Retracements, or the
Relative Strength Index to distinguish a bear trap from a
genuine trend reversal.
Before trading a bear trap, it's always important
to look at the technicals. If a strong bullish trend
suddenly and suspiciously moves downwards, instead of jumping in blindly,
it's always a very good idea to use our outside knowledge
to confirm how realistic that downturn might be.
The Aroon indicator was touched on earlier in this discussion
and when we talked about it, we were saying that it was initially
a good first step to help analyze how legitimate the trend
is, and I stand by that statement. The Aroon indicator signals
when is a strong uptrend or downtrend so we can get an idea
of how powerful the current trend is.
That way, we can avoid all of those temporary pivots in the
other direction, otherwise known as a bear trap.
If we want to avoid the bear trap entirely, one way we can
do that is to simply avoid selling short. Short selling is
risky, especially during bear traps, because our losses can
continue indefinitely. One of the ways to avoid losing unlimited
capital when shorting though, is to make sure that we're implementing
a stop loss order.
If we want to stay open, strongly advise paying attention
and making sure that we have a stop loss order in place.
The stop loss order will stop the bleeding, if you will, and will
cap our losses. A stop loss order is designed to limit an
investor's loss on a position, and it's placed with the broker
to make sure that we close out at a certain location, mitigating
the losses that we've already sustained.
Utilizing all of the different indicators that we talked about, or just getting
practice with identifying how a bear trap looks and what
it acts like, will help you avoid the bear trap in all reality.
The more you see it and the or you involve yourself with
bear trap examples, the quicker you will be to be able to
spot and identify and potentially avoid or take advantage
of a bear trap in progress. Because ultimately, if you have
correctly identified a bear trap, you have correctly identified
which way the market will most likely be going. If you
know which way the market will most likely be going, there's
always a way to make some profit out of that knowledge.
To sum it all up, a bear trap doesn't have to be a bad thing.
Ultimately, the better we are at identifying it, the better off
we'll be in general, because we will have control.
We'll be able to decide whether we want to trade it or whether we don't.
After this short video you should now be at least
a little bit more aware of what a bear trap looks like, how
to spot it, the different tools you can use to help you spot it,
and how you can potentially trade it.
But until next time folks, I look forward to you soon, but do me a favor and click
that like and subscribe button down below if you haven't because
it allows me to keep coming out with these videos for you guys.
I will see all of you soon.
Happy hunting. Happy trading. Over and out.