The market is a highly unpredictable place. Since trading has been incorporated and improved through the years, now, it's not just buying, selling, or exchange. Additionally, studies and developments were made to help traders, like the trade simulation system. But if there are tools to help traders, there are also traps to look out for. One of them is the bear trap.

What Is Bear Trap in Trading?

A bear trap is a condition in the market where the expected downward movement of prices suddenly reverses up. When prices in an uptrend abruptly drop, a bear trap follows. This phenomenon and market performance lure many traders in investing and buying in the market.

Most traders commonly don’t know how to trade bear traps or when they're falling into the trap. A bear trap trading happens when a trader, upon getting attracted to the falling prices, decides to put on a short position when a currency pair is falling, only for the price to reverse and suddenly goes up and moves higher.

How Does It Work?

Usually, other traders set bear traps where they sell assets until other traders are convinced that the upward trend has ended and the prices will drop. As the prices continue to drop, traders will be fooled into believing that it will continue.

And then the bear trap will be released as the market turns around and prices go higher. It’s a false market performance that leads to many traders losing money.

Bear Trap vs. Bull Trap

A bear trap and a bull trap are commonly interchanged or misinterpreted. In the market, these two are opposites. If a bearish trap happens when prices are dropping, bullish traps happen when the market rises and prices continue to move upwards.

Causes of Bear Traps

There are many reasons why bear traps happen or occur in the market. They can occur in any market and commonly happen because bears decide to drop or pull the prices down.

Additionally, the causes of bear traps include:

• Long downtrend or downward movement of prices in the market
• Unexpected events in real life that involve leaders and even politicians
• A continuous strong uptrend in the market

How to Identify a Bear Trap

A bear trap can cause any trader a significant amount of losses. To minimize this kind of risk when trading, it's for the best that you know what to look out for before you get caught in the trap. Some more technical indicators you should watch out for are:

1.     Divergence

Certain indicators provide divergence signals. When there's divergence, there is a bear trap. To look out for divergence, you have to check if the indicator and the price in the market are moving in different or opposite directions. Using this to determine whether a bear trap will occur, when the price and indicator are moving in the same direction, there's no divergence so that no bear trap will happen.

2.     Market Volume

The market volume is a critical indicator of a bear trap. There is a significant change in the market volume when a price is potentially rising or dropping. However, if there is no significant increase in volume when a price drops, it is most likely a trap. Low volumes commonly represent a bear trap since bears can’t consistently pull the price down.

3.     Fibonacci Level

Fibonacci levels indicate reversals of prices in the market since trend reversals are identified using fibo ratios. This also makes them a great indicator of bear traps. A bear trap is most likely to occur when the trend or price doesn’t break any Fibonacci level.

How To Avoid Bear Traps

Bear traps are risky, and the best way to not fall into any is to avoid them. If you get caught in a bear trap, you can quickly lose money. Here are some ways to help you avoid getting caught in a bear trap:

• Use candlestick patterns like a reversal candlestick. It’s an excellent indicator that can help you avoid bear traps. When you see this pattern formed in the market right after a downtrend, the price drop is too good to be true and will not last long.
• Observe the volumes. The volumes reflect the strength of a bear. If a volume indicator shows no sign of an increase in volume, there’s a low chance of the price being pulled down further by the bears. It’s best not to enter the market at this time.
• Widen your stop-loss orders and don’t place them under the support and resistance line. They should provide a buffer zone that can act as a breather when false breakouts or price drops happen.
• Bear traps happen when there’s a downtrend, so you should check the length of a downtrend. Observe how long the trend has been going and refrain from entering the market when there is a prolonged downtrend.

Bear trap trading is usually utilized for short-selling or shorting by traders. But still, it’s clear that bear traps are risky and best be avoided. You’ll lose more than you can earn. When trading, it’s essential that you know what bear traps are and what indicates a bear trap so that you can avoid getting caught in one. Be patient when trading and don’t get carried away by the price drop in the market.

The price per coin has so far been strong this year as traders and investors cheered the likes of Facebook and Apple showing interest in bitcoin, cryptocurrency and bitcoin's underlying blockchain technology. This weekend's drop was attributed to a lacklustre debut for the highly-anticipated Bakkt bitcoin and its cryptocurrency investment platform at the beginning of the week.

According to Forbes, the drop has caused panic among traders and investors who have been anticipated a drastic change for some months now. For the time being bullish Bitcoin traders are advising to buy as the markets look confused as ever, and there will be some results on the horizon. In addition, chief investment officer of Morgan Creek Capital, a US bitcoin and cryptocurrency investment company, suggests "buying the dip," clarifying that daily change sin the value of Bitcoin are rarely significant and should be ignored.

Daniele Mensi, CEO of Nexthash, the operating group of digital exchange platform Nexinter, commented on the price drop: "The volatility of cryptocurrencies is what makes them excellent conduits of growth for traders, investors, and growing businesses. What is important to remember is that Bitcoin is still up around 115% this year, so its short terms peaks and troughs are necessary to facilitate longer-term growth across the currency. It is important for new traders and investors to do their due diligence on each currency that they invest into to ensure that it is the right route for them, but institutional investors and high-growth companies will continue to look crypto and digital trading to facilitate international, fluid growth." 

Said markets present anticipated price developments daily, weekly, monthly and yearly, and when scouting for profits, bidding investors will act according to the market sentiment.

If the anticipated price development of a market’s stock is upwards, meaning the value of certain stock is rising or expected to rise, as a consequence of trends, single events, supply materials, current affairs or many other factors, the market sentiment is expressed as bullish. Vice versa, if the anticipated price development is on the downtrend, by any of the same reasons, the market sentiment is expressed as bearish.

It isn’t always as simple as this however. Market sentiment is also considered to be a contrarian indicator. For example, extremely bearish markets may subsequently display dramatic spikes – the turning point for this is often where the risky decision making appears.

Market sentiment, the overall expression of a certain market as bullish or bearish, is normally determined by a variety of technical and statistical methods that factor in the comparisons of advancing & declining stocks as well as new lows & new highs in the market. One of these is known as the Relative Strength Index (RSI); it relates the number of assets bought to assets sold, indicating whether capital is flowing in or out of the market in question. Normally, as a market follows sentiment either way, the flock follows, meaning the overall movement of the market’s stock follows the market sentiment directly. To quote a popular Wall Street phrase: “all boats float or sink with the tide.” The more investors buy, the more investors buy; it’s usually exponential development.

This of course could happen indefinitely, if it weren’t for the fact that as stock trading volumes rise, as does the price. Eventually the price hits a market high and the potential for profits is minimized. At this point the fall to a bearish market usually comes to fruition. On the other hand, as trading volumes fall, prices go down, to the point where eventually the price is so low it would be foolish not to buy, therefore turning the market on its head.

As obvious as it may seem, the words bullish and bearish reflect exactly what you would expect and are not simply paraphrases. An optimistic investor, happy to buy, buy, buy as the market sentiment is bullish, is considered a bull; aggressive, optimistic and almost reckless, striking upwards with its horns. Equally a bearish investor is considered a bear because he or she does not trade without utmost consideration, he or she is pessimistic towards trading expectations and believes prices will fall, or fall further than they already have. The bear therefore decides to sell, sell, sell, and pushes the prices down; as a bear that strikes its paws to the ground.

Make sure you check one of our top read features ‘The Top 10 Greatest Stock Market Trades Ever’.

Winans Investments has created a history book, ‘Investment Atlas II’, which examines all US presidents since 1849 and how stocks, bonds and housing performed during their terms.

Their research has found compelling comparisons to past presidential elections. In the wake of Trump's victory, the media is focusing on parallels with "Give 'em Hell" Harry Truman's surprise 1948 victory over Thomas Dewey, or the "Hanging Chad" mess of 2000 that required the US Supreme Court to rule in favor of George W. Bush.

However, investors should focus on the Carter-Reagan transition of 1980-81 in which the 9% post-election stock market rally ushered in one of the greatest investment booms in US history!

While today's economic picture is not identical to the 1980's (especially when it comes to the level of interest rates and inflation), there are Reagan/Trump positive similarities that investors need to know:

Lower Business Taxes- Since 1913, US corporate income taxes have ranged between 1% - 53% with the current tax rate at 36%. The Trump plan to reduce business income taxes to 15% would be the largest tax cut for corporate America ever! Bottom-line: lower business taxes suddenly makes US stocks attractively valued versus other global investments.

Reduced Regulations - The regulatory pendulum is swinging away from post-Great Recession punishment towards deregulation in order to spur economic growth. This has caused a large shift in stock market leadership towards financial services, manufacturing and energy shares.

Lower Investor Taxes - In addition to a proposed reduction in individual top tax rates from 40% to 30%, investment related taxes (capital gains, dividends, etc.) are likely going to be substantially reduced. The Trump plan also calls for phasing out the Obamacare investment tax and lowering tax rates for short-term capital gains.

Stronger US Dollar - As economic growth expands, a country's currency should increase in value. Similar to the US dollar's historic rally in 1985, demand for foreign purchases of US stock, bond and real estate investments should boom!

There are other positive economic developments to also consider:

Gradual Interest Rate Increases - It appears that the Federal Reserve will not make the mistakes it made in the late 1930's when it mishandled exiting its Depression Era "0% interest rate" policy and triggered the Roosevelt Recession. Today, inflation pressures are relatively low, and the process of raising the Fed Fund's Rate ¼ point at a time will gradually return the US to a normalized interest rate environment while economic growth accelerates in a healthy manner.

Republican Controlled Congress - Unlike Reagan, who faced challenges from a Democrat controlled Congress through his entire presidency, Trump should have a faster & easier time enacting much of his pro-business agenda over the next two years.

Lots of Fuel For an Extended Bull Market - Since 2008, many investors have kept large amounts of cash in money market accounts and CDs. As the economy expands over the next few years, much of this money could be invested in US stocks. There could also be an investment shift from low yielding municipal and treasury bonds into US equities.

With the Trump administration's ambitious economic agenda, US common stocks should greatly outperform income investments and could achieve annual returns not seen since 1990's average annual returns of 19%!

What Should Investors do?

Investors that do not need investment income and have an average tolerance to financial risk should consider reallocating their portfolios into more US common stocks.

However, any reallocation into more stocks is not without risk. Historically, US common stocks have negative years 27% of the time and serious bear markets 8% of the time (like the 50% corrections suffered in the Dotcom Bust of 2000-02 and 2008-09's Great Recession). Simply put, any decision to increase exposure into more stocks must include a disciplined plan to exit the stock market when key market indicators turn negative in the future.

(Source: Winans Investments)