Bears prefer declining markets with the opportunity to buy assets at a lower price. However, getting into a bear trap and losing money is definitely the situation one would like to avoid. The possibility of getting lured into a trip is extremely high today, while practically all major markets male unexpected moves. This fact makes it pretty hard for buyers to foresee if a given asset is likely to reach the price bottom or go even lower.
In this article, we will discuss the situation that is associated with the bear trap in stock market as well as ways to avoid it. Besides, we will explain the difference between bull trap vs bear trap.
Also known as the bear trap pattern, the situation describes an asset with its price unexpectedly moving downwards. This fact makes the majority of market participants become short sellers. At the same time, the situation can be followed by sudden upward price reversal keeping short sellers lose their investments, as the price goes higher. It all ends with the margin call. To prevent it, some investors borrow more shares to back their positions, which can lead to a bigger debt.
Note: the good news is that bear trap is generally a short-term occasion. The pattern is mainly associated with technical trading as the part of the bearish investment strategy. The methodology will not work for those who prefer buy-and-hold or long-term trading strategies.
To have a deeper understanding of how bear trap works, we need to clarify the difference between a bull and bear trap, so you could see the main causes, features, and other factors that can help you define a specific market condition.
Both “traps” are quite similar, as both deliver false signals putting investors’ backs behind the wall. Those signals announce a breaking trend making market participants make inappropriate moves. At the same time, a false reversal makes a move back to the original trend leaving investors with margin calls and huge losses. This is where both situations are similar.
As for the differences, they are as follows:
As we stated earlier, the main features that define an upcoming bear trap involve not only sudden price moving downwards but also moving below the key support level. So, we can see bearish investors trapped between the downtrend movement and a sudden price reversal upwards.
The main causes can be the following:
The only way to prevent getting into a bear trap is to avoid it. It means, a trader should not enter the same position together with the rest of investors. Here are some practical tips that you may find useful:
When getting into a bear trap, investors can find their security prices declined. This fact generally triggers bearish activities, while the majority of investors usually go short. It results in lost capital and reduced asset value, while the price will inevitably make a reversal and reach the original heights.
This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.