A Bull Trap is a false bullish signal in a bearish trending market. This sudden rise convinces investors that the asset is entering a bullish phase (characterised by a positive trend), prompting them to open positions. However, after a brief rise, the market rebounds in a bearish trend, ‘trapping’ investors who were hoping to profit. It is no coincidence that the term Bull Trap refers precisely to the Bull Market, a financial market characterised by a strong positive trend.
Bull Traps are one of the biggest pitfalls in trading, and can occur within any financial environment.
The other side of the coin of the Bull Trap is the Bear Trap, which takes its name from the Bear Market. The substantial difference between Bear Traps and Bull Traps lies in the trend of the market under consideration and the false signal. In a Bear Trap, the market in a bullish phase undergoes a temporary reversal of the trend that leads investors to close a position, causing them to lose potential profits.
How can you recognise a Bull Trap? There is no foolproof method, but in general it is important to carry out a careful technical analysis of the market and learn from past bull traps.
Bull Traps sometimes present a recurring pattern. Before entering a market, you should carefully evaluate the associated trading volume. Trading volume is a very useful figure in financial markets as it is the sum of all quantities of an asset sold and bought in a certain period of time. When an asset is actually in a bullish phase, institutional or expert investors are more likely to enter the market in a timely manner, consequently leading to an increase in trading volume. If, on the other hand, volumes remain unchanged or change little during a price rise, this could be a bull trap.
If you are still uncertain about whether or not a Bull Trap has occurred, you can look at another indicator: momentum. This value analyses the change in a market’s prices over a certain time frame and helps to determine which trend it might follow in the future. Simply put, it is a technical indicator that helps us understand whether an asset will continue to rise or fall. This means that if the price of an asset starts to rise but the momentum value remains unchanged, we could be facing a bull trap. Usually, in a bullish trend, the value of the momentum indicators rises along with the price.
There are various other technical analysis tools that may or may not confirm the presence of a Bull Trap. In general, the golden rule for all investors to avoid a Bull Trap is not to get carried away by your emotions. If the value of an asset suddenly rises, it is essential to analyse the market with a clear head, without getting caught up in FOMO (Fear of Missing Out) and taking hasty actions.