- A bull trap occurs when the price of an asset falls and experiences a brief increase in value
- Bullish traders can fall prey to this short-term price spike and suffer losses when the downtrend continues further
- Low trading volume and high RSI are two important signs of a possible bull trap
The crypto space can often be a playground of deception to manipulate the market, and one such example is a bull trap. A “bullish trap” is a particular pattern where traders are manipulated into buying when the market is in a downtrend which could ultimately lead to serious consequences for the trade.
This article will explore what a “bull trap” is and how to avoid it.
What does it mean in cryptocurrency?
A bull trap is a false market signal that traders might see when a strong futures bearish asset suddenly appears to rally; however, in reality, the asset is about to drop further in the long run. In a bull trap, traders notice a downtrend in anticipation that the cryptocurrency may get a bullish reversal and buy the cryptocurrency at a good price. This type of situation occurs during times of market volatility or when false information about a cryptocurrency is spread.
The term “trap” is associated with the phrase because it conveys a false sense of security that cryptocurrencies are on the rise, which is contrary to reality and can lead to heavy losses. The price of a cryptocurrency in a bull trap usually breaks past the asset’s previous support levels, making traders believe that the price of the cryptocurrency is rising, leading them to open new long positions or invest more in that particular asset.
Also referred to as a “dead cat bounce”, in the crypto space, you must always be on the lookout for a sharp reversal in the value of an asset soon after its breakout. This type of uptrend is actually short-lived and is ideal for temporary moves instead of a long position.
How to identify it?
There are a number of factors that lead to bull traps in the cryptocurrency trading space, and one of the most common is buying the dip prematurely in hopes of a market low. Bull traps occur when traders assume that the market’s downtrend is over.
However, a false upside breakout coupled with an early entry is less likely to sustain itself as the market lacks large buyers. This leads to sellers overpowering scarce buyers, which results in prices adjusting to lower levels. The problem escalates when a buyer’s trade begins to fluctuate at a small loss, and escalates even more as market prices continue to readjust to lower levels.
Given this challenge, traders tend to rely on technical analysis and chart reading to identify if a price pattern is potentially developing a bull trap.
You can spot a potential bull trap by spotting a high RSI. The RSI, or Relative Strength Index, is a technical indicator that determines whether a cryptocurrency is underbought, overbought, or neither. When a possible bull trap occurs, a high RSI and overbought circumstances suggest that there is increased selling pressure. This leads to the first breakout and the uptrend, which soon loses its momentum and most traders risk closing their trades at any moment.
Of course, the market tends to move in cycles, which means that when it reaches the peak of a cycle, it enters a consolidation period where bulls and bears fight for control. When you notice that the cryptocurrency is experiencing a sharp downturn but there is a slight bounce. This can be an early sign of a bull trap. A lack of momentum is an early sign that the market is headed for a reversal.
Absence of volume increase
No increase in trading volume, implying that there are not many traders buying the stock. It is also an important indicator of a possible bull trap. This means that it may not be sustainable in the long run, despite short-term price increases. The price increase could also be due to bots and retail merchants competing for position.
There are many descriptions of a “range” in trading. But the most common is the size of each candle. In a bull trap, when the initial downtrend occurs, range expansion indicates that there is strong momentum. When there is no range expansion when it is bullish. It indicates a weak rebound and that prices are vulnerable to further adjustments.
When you notice the price of a cryptocurrency falling below its previous low, it could indicate a bull trap. When a break below the previous low occurs, a series of lower highs and lower lows continues. This leads to the sustainability of the bull trap. Subsequently, prices tend to move correctly downwards.
A “bull trap” is a common scenario in the crypto space that can result in significant losses for traders. However, you can easily avoid these scenarios by waiting for technical indicators to signal an incoming bull trap. The key here is patience and due diligence, which will help you have a positive trading journey.
Does the bull trap have a bearish or bullish sentiment?
Bull traps are bullish in the short term but bearish in the long term.
How to avoid a bull trap?
To avoid a bull trap, you can look for confirmation after a breakout has occurred. Confirmations may include, for example, looking for above-average volume combined with bullish candlesticks to determine whether or not the price will go higher after a breakout.