What is a bear trap in Crypto

Key Takeaways:

A bear trap refers to a false technical indication of a reversal from an uptrending market to a downtrending market.

Bear traps occur in all asset markets, including currencies and cryptocurrencies.

Bear traps can manifest as a form of downside market correction within an overall bullish move higher.

Although this is a difficult proposition for novice traders, they can use charting tools to recognize a bear trap.

Introduction

A bear trap refers to a technical pattern that forms when the price action of a stock or any other financial instrument mistakenly signals a reversal from an uptrend to a downtrend. In simpler terms, the prices can move higher in a broad-based slope. It then encounters significant fundamental resistance or change, prompting bears to open short positions.

In the cryptocurrency market, a bear trap generally involves multiple traders holding a significant amount of combined cryptocurrency holdings. They can plan to sell a large amount of a particular coin at the same time. This gives a false indication that other market participants think a price correction is taking place. They sell their own holdings in response, driving prices down even further. Once the bear trap is released, the group buys back their assets at a lower price. This causes the value of that coin to rebound, allowing the trappers to make a profit.

How does a bear trap work in the crypto market?

More often than not, novice traders are caught out by price volatility when trading in the cryptocurrency market. While it is always recommended to stay for the long term to take out such volatility, price reversals can confuse even the most experienced traders. This makes it essential for traders to identify the signs of a false reversal. Increased volatility can tempt short-term traders to time the markets, resulting in losses for the majority.

For markets trending upward, a sudden downward price movement can increase volatility, forcing market participants to go short the underlying asset or liquidate long-term holdings. This form of market manipulation is called a bear trap in crypto. The main purpose of this move is to trick bearish participants into believing that this is an indication of the beginning of a downtrend. This is often followed by a sharp resumption of the previous uptrend.

How do groups of traders benefit from a crypto bear trap?

Groups of traders coordinate with each other for the joint sale of a specific token. This causes the token’s price to drop, influencing other retail participants to believe that the uptrend is over.

As a result, many investors tend to sell their holdings, driving the price down even further. The influential trading groups then proceed to buy back the sold quantities of tokens when they break below the previously held lows. This causes a sharp upward movement that traps bearish bets. Consequently, the trading group takes advantage of the difference by selling at a higher price and buying back at a lower price.

How can traders identify and avoid a bear trap?

Traders can use trading indicators and technical analysis tools such as volume indicators, Fibonacci levels and RSI to identify a bear trap. They can use these tools to confirm whether the trend reversal after consistent upward price movement is real or fake.

To ensure that there is not a bear trap, traders should check if the downtrend is being driven by high trading volumes. Some of the most obvious signs of a bear trap forming include a combination of factors such as price pulling back below a key support level, low volumes and failure to close below critical Fibonacci levels.

Crypto investors who have a low risk appetite should avoid trading during price reversals that are sudden and unfounded. They need to see if the price and volume action confirms a trend reversal below any important support level. For traders, it makes sense to hold their cryptos and avoid selling unless the price has breached the stop loss level or the initial purchase price.

Every trader needs to understand how crypto reacts to crowd psychology, sentiments and news if they want to avoid a bear trap. This is easier said than done, due to a large amount of volatility in the crypto market.

Traders looking to profit can get a put option and avoid becoming a short seller or long seller. A put option avoids the exposure to unlimited risk if the crypto resumes its upward trend, which is not the case with short selling.

By using a put option, a trader limits his/her losses to the premium paid. This prevents it from affecting the long crypto position held from before. In the case of long-term investors, it is better to stay away from trading during a bear crash.

Frequently Asked Questions

Can a bear trap be traded by bullish or bearish traders?

Since a bear trap involves both a downward and upward movement, both bearish and bullish traders can trade it using different strategies with potential outcomes.

How is a bear trap different from a bull trap?

A bull trap is the opposite of a bear trap. Here, traders assume that a downtrend is reversing and start taking long positions, only to later realize that the market has resumed its downtrend.

Can traders recover from a bear trap?

If a trader gets caught in a bear trap, his/her PnL will be significantly hurt as these traps are quick moves that offer no chance to recover. To preserve their PnL, traders must understand the underlying market movement during a bear trap to identify it.