Bull Trap Trading Guide: How to Identify And Escape
All traders have memories of trades that appeared very obvious to them, but, once they were in, the trades turned against them and ended as losers.
Those are known as “trap trades” as they lure unsuspecting traders and then whipsaw them once they take the bait.
One of the most common trap trades known to traders is known as the bull trap. In this article, we are going to define a bull trap, see how to spot one, learn to avoid them, and then reveal some ways may be possible to profit by trading them.
What Is A Bull Trap?
A bull trap is an occurrence that happens during an uptrend. The price of an asset goes up until it reaches a resistance level. Here, it takes the typical break expected by all traders, and then, later on, it breaks past the resistance level.
The pattern is very tricky in that it might give “confirmation” of breaking past the resistance level. This makes any traders watching the price behavior believe that the bull rally is proceeding, so they execute buy traders.
Woe unto them, a few candles later, the price makes a sudden and aggressive U-turn and a bearish move begins. Those with stop losses have them taken out as the rest are left holding onto losing trades.
The figures below demonstrate how a bull trap happens.
So, what really happens during a bull trap?
A bull trap is most likely to occur after a long bullish trend. This is a sustained upward movement of the price that has been active for a long time.
It means the buyers have been in control for a very long time and are most likely about to exhaust their resources. This assumption becomes valid when the price eventually enters a resistance zone. The price usually slows down as shorter candlesticks start forming. We can match this occurrence to a significant number of long traders (buyers) taking their profits at the resistance level.
After this, the market slows down before more buyers jump in and try to push the price past the zone of resistance. This leads to the formation of a “breakout.” Unsuspecting buyers see this as a continuation of the uptrend and they execute more buy trades.
However, since most buyers have exhausted their resources, the sellers start pumping in their orders since they dominate strong resistance zones. The keen buyers who know this phenomenon start closing their trades. The sellers, upon seeing reducing buyer volumes, pump in more sell trades.
The resulting imbalance of escaping buyers and the aggressive sellers causes the trend to tilt in favor of the sellers. As the trend sinks lower, it takes out the stop losses of the new buyers, making the sellers even stronger.
The buyers who thought that the trend would continue rallying upwards have their stop losses activated. As for those with wider stops, or those without any stops, they remain trapped in a trend that has turned against them.
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How Can I Identify a Likely Bull Trap?
Identifying a bull trap can be easy if a trader knows what to look for. The following are some common tell-tale signs that a bull trap is about to occur:
1. Multiple Testing of Resistance Level
The first hint that a bull trap is on the way is a strong bullish trend that has been sustained for a long time, but it reacts significantly to a specific resistance zone.
A strong uptrend with minimal bearish interference means the buyers are pumping in everything they have. However, when they take the price to a certain resistance level, they tend to fear or respect it, and the price pulls back before going even higher.
See the illustration below.
However, after the price reached the marked resistance level, it would slow down and pull back a little before pushing higher. As we can see, there were three tests before the bear trap eventually happened.
As such, one way to identify a potential bull trap is when the price makes significant stops on a resistance level after a long sustained uptrend.
2. Unusually Huge Bullish Candlestick
In the final phase of the trap, there is usually a huge bullish candle that dominates most of the immediate candlesticks to the left.
This candlestick might have several explanations behind it:
○ One, that new buyers believe that a breakout has occurred and they start buying again
○ Two, that maybe some big players are intentionally pushing the price higher to lure unsuspecting buyers, or,
○ Three, the sellers have cunningly let the buyers dominate the market momentarily so that sell limit orders above the resistance zone can be activated
Check the two above images and confirm that a huge bullish candle formed immediately before the trapping happened.
3. A Range Is Formed
The last characteristic of a bull trap setup is that it forms a range-like pattern on the resistance level.
A range means that the price appears to bounce back and forth within a support and resistance level. This range might not be perfect, especially on the upper side, because the market might still be making smaller higher highs.
It is easy to spot the start of the bull trap because the huge candle discussed above forms and closes outside this range.
Look at the following image and see how a range forms before the trap.
The Common Bull Trap Patterns Examples
There are multiple ways that a bull trap can manifest itself. However, all of them will follow the typical concept that a resistance level will be intercepted, the price will attempt to break past it, and then the market will come crashing.
Below are 3 classical bull trap pattern examples.
Pattern #1: The Rejected Double-top
The rejected double-top pattern is characterized by two protruding candlesticks that resemble the normal double-top pattern, only that this time; the second candle shows massive rejection on the upside.
In this illustration, the ranging behavior at the resistance level as well as the huge bullish candle can be seen. Therefore, it qualifies as the perfect bull trap formation.
Pattern #2: The Bearish Engulfing
Candlestick patterns and formations are very important when seeking to identify potential market turning points.
Similarly, they are very useful in identifying and completing the bull trap formation. When an engulfing pattern forms after the classic bull trap pattern has formed, then it is a straightforward indicator that a strong bearish move is about to happen.
See the engulfing pattern in this chart:
Note: There are hundreds of valid bearish candlestick formations that can complete a bull trap pattern. As such, a serious trader should be able to easily pick them out in critical areas.
Pattern #3: The Failed Re-test
Another common bull trap pattern is seen when, after breaking past the resistance zone, the price comes back to test it, but fails and crashes.
Experienced traders understand that this is the ultimate test of the continuation of a trend after breaching a major support or resistance zone.
That said, if after breaking past the resistance level, the price tests it again but fails to gain upper momentum, then another classic bull trap pattern is created.
The image below illustrates this occurrence.
As for the experienced ones, they waited for the price to come back and test the resistance zone again. The price, indeed, came down for the re-test. However, rather than bounce back up, it ranged for some time, received significant rejections to the upper side, then melted rapidly.
From this, a perfect bull trap was formed.
How to Avoid the Bull Trap?
1. Avoid Late Entries
From the descriptions of a bull trap, a long sustained uptrend is usually a potential sign of this cunning pattern. In short, the longer an uptrend has traveled, the more likely that it will form a trap.
That said; a trader can avoid bull traps by steering clear of late entries. If a trend has been running for a period deemed as “too long”, then it is best not to trade it.
Keen traders, both buyers, and sellers know that careless traders will come in and add trades during pullbacks. They then lay in wait and lure them by reversing the trends when they least expect it.
2. Don't Buy at Resistance Levels
One of the most sung melodies in the world of trading is, “trade with the trend.” There is no better way of doing this than buying at support levels and selling at resistance zones.
If this concept is worth respecting, then a trader should never attempt to take buy trades at resistance levels. There are exceptions, though, such as if the price re-tests the zone after breaking it and confirms the start of a fresh trend.
All the same, it is riskier to take buy trades at resistance level than buying at support zones.
3. Wait for Re-tests
There is no fixed rule that buying at resistance-zones-turned-support is wrong. Traders know that a support zone, when broken, becomes a resistance zone. In the same way, a resistance zone, when broken, becomes support.
In a nutshell, a trader should always wait for the price to not only break a resistance zone but also retest it and gain upper momentum before executing their buy orders.
In fact, buying at the retest means the trade is much lower than one placed at the top of the breaking candle. Therefore, less money would be lost in case the trade became a loser.
4. Observe Price Action
Traders can avoid bull traps by observing price action. Price action refers to the genuine behavior of the price at any given time.
Now, while watching a bull rally approaching a resistance level, the trader should be keen to note what the price does. For instance:
★ Shorter candlesticks start forming when the price touches a resistance zone. At this time, there is neither volume nor momentum to support trading.
★ If longer bearish candles are formed, complemented by short bullish candles, this is an indication that the bears are taking over the market direction. Do not take buy trades
★ If the candlesticks at the resistance zone have long wicks on the upper side, it means the bears are restraining the price from going any higher. If buy trades are open here, they will only be profitable for a short time before being pushed lower and trapped.
In short, price action is the surest way of reading the market and avoiding bull traps as they form.
How to Trade Bull Traps?
Method #1: Buy the Retests
As earlier mentioned, if you need to buy at a resistance level, wait until the price comes down to retest it then open a buy order.
Such signals can be further confirmed using other methods such as candlestick formations or indicators. For example, if, after a retest on the zone, a bullish engulfing pattern is formed, it is safe to open the buy trade.
● They would wait until the price touched the resistance zone. After several candlesticks ranged on the level, one of them broke out above it and a bullish pattern formed thereafter.
● Now, rather than take this trade, the trader waited for a retest. The price went higher but a huge bearish candle brought it back to the resistance level (now support). This became the much-awaited retest.
● After the retest candle, the price closed above the support level. After a short period of ranging here, it formed a huge bearish candle that engulfed the previous bearish candles. This acted as the buy confirmation.
● The trader then placed the stop loss below the support zone and the take profit above the highest candlestick or on the next resistance level.
● In as much as the trade came back down, it did not break past the support level, so the stop loss was intact. To the trader’s delight, the trade recovered and went back up towards the take profit level.
That is one method of trading bull traps safely.
Method #2: Short after a Successful Trend Change
The safest way to trade a bull trap is to accept that the trend has changed and flow with it.
The illustration below explains it:
● So, the trader did not open any trade but waited for the price action. As it would be, the price experienced rejections on the upper side and came back to test the former resistance zone. Upon testing it, it closed below it, meaning an uptrend was very unlikely, so the trader expected a sell trade.
● He did not execute the sell trade immediately but waited for a retest as confirmation.
● Eventually, the market went down a little, then back up to the resistance zone. It successfully did retest which formed a bearish engulfing pattern.
● If the trader took this trade, his stop loss would be placed above the resistance zone. The take profit would be on the next support level.
● The trade was successful!
In a nutshell, that is how a bull trap is safely traded for easy profits.
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Conclusion
Bull trap patterns are known to lure traders into taking risky trades that almost always end in losses. As such, many traders shiver when they hear the phrase being mentioned.
However, by understanding how bull traps form and what they mean, they can become profitable setups. In this post, we have seen how bull traps can be identified and even traded while minimizing the risks and maximizing the gains.
This lesson adds to the fact that the market is very rewarding if only the trader knows how to read it.
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* The content presented above, whether from a third party or not, is considered as general advice only. This article should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments.
