A Bear Trap is a false bearish signal within a bullish trending market. This movement confuses investors into believing that the market is undergoing a trend reversal and is entering a bearish phase (i.e. a downtrending market phase). In order to minimise their losses, investors are led to exit the market immediately.
However, after a brief descent, the market continues in a bullish trend, causing investors to miss out on potential gains.
The term Bear Trap owes its name to the Bear Market, a market phase characterised by a generally negative trend.
The Bear Trap is a trap present in all financial contexts, from trading to the cryptocurrency market. It is not to be confused with a Bull Trap, a bullish trap in a bearish trending market.
It is not possible to accurately predict market movements, but in general there are certain recurring causes that can generate a Bear Trap.
Certain events outside the market, such as a speech by an authority figure or changes in geopolitical order can lead to a momentary feeling of distrust or fear. This may momentarily lower the prices of a market, causing a Bear Trap.
Sometimes a Bear Trap can also be caused by coordinated movements of other investors within the market. If a group of traders simultaneously sell an asset, in accordance with the law of supply and demand, the price of the asset will fall. This movement generates a Bear Trap and pushes other traders out of the market. Then, this allows the initial investors to buy the asset again at a lower price and earn more profit, causing the price to immediately rise again.
How can you recognise a Bear Trap? Unfortunately, there is no foolproof mathematical technique. In general, it is important to make a careful analysis of the reference market and above all not to panic.
For example, if you have difficulty identifying a Bear Trap, you can take into account the trading volume. This figure is the sum of the quantities of an asset sold and bought over a certain period. When a market is entering a bearish phase, most institutional investors will try to exit the market by selling their securities. As a result, an increase in trading volumes will be observed.
If the trading volumes of an asset remain unchanged, you are most probably facing a Bear Trap.
The financial market is impossible to predict. It is important for every investor, if they suspect they are facing a Bear Trap, not to get caught up in their own emotions, and to carry out a careful technical analysis before each trade.