Bear trap trading is taking a bearish position on a stock because you believe it will go down. Traders look for bearish patterns, such as bear flags or bear pennants, to take a short position and get paid when the stock drops in value. What sometimes happens to these traders, though? BAM! Caught in the trap! The trade becomes a losing position, and they get stopped. Trading is a battle between the bulls and the bears. As a result, each side constantly vies for power. Do you know how to spot bear traps? Don’t worry; we’ll teach you to spot these bear trap stocks.
What Is Bear Trap Trading?
The basic definition of bear trap trading is when a bearish chart pattern occurs and falsely signals a reversal of the rising price trend. What you see is a reversal pattern that has formed on an uptrend. You think the price will fall and continue down, and it doesn’t. Price begins to trade sideways or goes back up. Usually, you missed support or missed the overall uptrend, and you should have bought the dip instead of shorting the stock.
Shorts Get Trapped
Short traders get trapped. And it causes a short squeeze – meaning those traders need to cover the shares they shorted, and it causes the stock to rocket up. When you can spot short squeezes, you can make some pretty good money from the momentum. I check the short float by using my Trade Ideas scanner.
With trading, you use technical analysis and patterns to predict the movement of a stock. There’s no magic formula that will predict how a stock will go 100%, but you can have a higher probability trade if you are systematic in your approach. You need to know patterns and have great risk management. You’ll only get that if you study, and our site has everything you need in one stop.
Alright, so bear trap trading tends to occur at the market open. With all the volatility in the first fifteen minutes, the direction of a stock could go either way. But it can happen at any time frame, too. The bottom line is it hits support and dips slightly below, and bears jump the gun, thinking support has broken and a new downtrend has formed.
That’s why tools like Fibonacci retracements and volume indicators are quite helpful in identifying traps for either bulls or bears. Have a system to manage that entry if it doesn’t work out as planned.
Short Selling
Bear trap trading happens when short sellers want to make money, but the bulls aren’t finished with the stock yet. Shorting is when you borrow a stock from your broker to buy back at a lower price.
It’s simple if you understand how it works and use proper risk management.
You never technically own the shares because you’re borrowing them from your broker and selling them to someone else. It’s like borrowing your buddy’s tools, doing a job with them, making some money, and returning them in pristine condition. Your broker will lend you the shares because someone else, typically a long-term investor, is sitting on shares. He is willing to rent them out to his broker for a fee that the broker passes on to you when you borrow the shares. The broker gets paid when he handles the transactions, like a middleman.
If you’re going to short, do yourself a favor and short at a strong resistance level. Daily, weekly, and hourly levels tend to hold more weight.
Bear Trap Trading Example
The bears set some traps intra-day on $BYND after it had ripped most of the morning. The stock sold off, creating some bear flags, and eventually, the bear flags failed at support and trapped shorts.
Making Money on the Way Down
So, as you now know, when shorting a stock, you need the price to move down. You got a good entry. As the price falls, you want to know where support is ahead of time. Once the price hits the support you identify, or the one you MISSED and didn’t know about, you cover your position. By covering, you’re buying the shares back at a cheaper price. Those shares then go back to your broker. Everyone made a profit as long as they bought back the shares at a cheaper price.
Avoid the bear traps in trading to increase your odds of getting that profit. However, there will be times when you open new positions and fall into a bear trap. You’ll need to cover your position to minimize loss if caught in this situation. Don’t let it run away.
Short selling is risky because, technically, you could lose your shirt. If you’re shorting a biotech stock, the price could go up 100′ percent (or more) by the time you check the price. If you go long, a stock can’t go below zero, so you’d only lose what you put into the trade.
Again, with shorting, a stock can keep going for an unlimited amount. Therefore, you can lose infinite money by not covering your losses quickly. This is why people use stop orders or avoid shorting.
Put Options
Put options are another way you can get caught in bear trap trading. Options give you the right but not the obligation to buy (call) or sell (put) a stock at a set price within a certain time frame.
As a result, taking the put side is taking a bearish position. Many brokers aren’t great shorting brokers because they don’t have the shares to sell. However, most brokers allow options trading, which lets you do the same thing but more safely. However, you can still get caught in the bear trap while trading options. The patterns are the same.
Since options are deteriorating over time, picking the right direction is important. Choosing the wrong direction can result in losing the entire trade if you hang onto it. Suppose you get caught in the bear trap while trading; close the trade and don’t let it run in the wrong direction. There is always another trade.
Options have more moving parts than stock. That makes them both more profitable and more risky.
Stopping Bear Traps When Trading
The best way to stop bear traps when trading is first to know candlestick patterns and support and resistance levels. Also, have mental stops in place before taking a trade, and stick to them. Bear traps are relative to your trading time frames, so look for reversals on specific time frames for your specific trade plan.
Trading Tools
You’ll encounter bear traps more often the longer you trade. They will always be there. The goal is to recognize the trap and to avoid it. That’s why having great technical tools is so important…
Traders often want to jump early on a move to make more profit. Greed can suck you into a bad trade. I use TrendSpider to check multiple time frame charts vs. different time frame candlesticks on the same chart. It’s helped a lot.
Volume is a great indicator of a trap being set. Don’t play that move if you see a breakdown in price with low volume. It’s not enough selling pressure to indicate a problem. That’s a serious clue that a bear trap may be in place. It would be best to have an increasing volume during a trend change to be valid and confident.
Using Fibonacci retracement tools is another great tool for identifying a trend reversal. If the price doesn’t break key Fib levels, then it’s more probable than not that a bear trap is about to occur.
Using MACD or RSI is another tool to identify bear trap trading. Price can fall, but the MACD or RSI is still bullish. However, this is a lagging indicator, so could you make sure you have confirmation? If the price is falling, but the divergence is still bullish, then it’s probably a trap.
Final Thoughts on Bear Trap Trading
Bear trap trading isn’t 100% avoidable, and being careless or dangerous is preventable. Indeed, with the right training, you can learn the tools and techniques to identify possible traps. It’s called a bear trap because the pattern lures short traders to take positions only to have prices reverse. Using proper risk management helps to keep any losses to a minimum!
