Last time we learnt about Trading The Bull Trap. Today, let’s trade the bear trap. And no,we’re not talking about a bear trap for eight hundred pound grizzlies. We’re talking about a different kind of bear -The naive selling bear. Basically, the principle behind the bear trap is still the same as the bull trap – Setting us naive bear traders for a major crash. Except that this time it’s naive sellers taking the bait. So we’re going to find out what a bear trap really is, the characteristics of a bear trap to look out for, how to avoid the bear trap, and how to trade the bear trap.
I guess the obvious question is:
What is a Bear Trap?
A bear trap is basically a contraption set up in the bullish trend for naive sellers.Just like their brethren, caught in the bull trap, they fall for the possibility of making a huge profit. except this time, they get baited into believing tha And just like their naive bulls brethren,they’re left holding the bag. To make matters, they’re in a lot of pain. Why? Because all their initial profits are about to go out in smoke and their precious stop loss is about to take a massive hit. Basically these naive bears are about to incur a huge loss. They basically started counting your eggs before they were hatched.
Let’s see a classic example of a bear trap
This is a bear trap in action. The red bears downward slide create the impression of an imminent sale only for the green bulls to set a bear trap, at the support, level jack up the price and head for the hills. Unfortunately the naive bears they face the double-edged sword losing a lot of money and their stop loss order taking a massive hit.
Twos Features To Look Out For In A Bear Trap
There are two features you absolutely need to look out for in a bear trap. The first candlestick must be absolutely bearish. It must be seen to be breaking through the support level and closing after the support level . Even more important, the next two bears in between the bear trap must be seen to be losing steam. When this takes place, shorter candlestick body lengths take place. This represents the formation of a bullish reversal.
The second feature to look out for is the bear trap breaking through the support level. The bear trap breaks the support level and the bulls head for the hills, leaving the naive bears holding the bag. When this scenario unfolds,you have yourself a bear trap.
Let’s see an illustration of this scenario using the first graphic we looked at earlier
Take a close look a the long red candlestick breaking through the support level and closing after the support level. That’s the first feature of the bull trap. However, take a closer look at the red candlesticks in between the bullish at the base of the support level. They’ve started losing steam and the bullish trend represents the bear trap breaking through the support level. The naive bears are going to be hurting a lot.
If you are still not sure about support/resistance levles please hurry to my Identify Support and Resistance Levels With Price Action Analysis post.
Where Do Bear Traps Occur?
As the purple line suggests, bear traps occur at support levels. Anytime you see candlesticks nosediving towards the support level, start screaming BEAR TRAP! Don’t be a victim.
Now that we know about the monster called the bear trap,What are we going to do about it? Hear are a few tips on how to dodge the bear trap
Place A Large Stop Loss
Just like the bull trap, place a large enough stop loss to get you out of trouble when the bear trap rears its ugly head. . You can place the stop loss at least 2 pips below the low of the bullish candlestick or two pips below the low of the bearish candlestick. Let’s take a look at the following graphic.
The first stop loss is placed right underneath the low of the bullish candlestick(or the short end of the candlestick), as indicated by the number one label. The second stop loss is placed at the long end , or low of the red bearish candlestick as indicated by the number 2 label. As I said earlier, placing a stop loss at either the bearish end or bullish end will save you from incurring huge losses.
If you’re a bit dodgy on your candlestick patterns, go to my post on You Need To Know Ten Of These Candlestick Patterns
Follow The Dominant Trend
If you want to beat the bear trap,follow the dominant trend-in this case the downtrend. If the breakout at the support level is not in the direction of the downtrend,it can only mean one thing -BEAR TRAP! And you know very well that the smart bulls will be only too glad to push the price up and head for the hills, and leave the naive bears licking their wounds. In case you’ve forgotten what a downtrend looks like,take a look
As you can see the breakout is in the direction of the downtrend.It has not taken any detours as you saw with the bear trap. If this scenario doesnt unfold on your screen, don’t bother entering a trade. If you do,you’d live to regret it.
If you’re still not sure of your trend trading, refer to my Trade Trends With Price Action Analysis Post
Trade Retracement Instead of Breakout
Sometimes it makes sense to trade the retracement instead of the breakout at the support level. Some of you are probably wondering “What is a retracement?”Well, a retracement is a temporary reversal of a currency pair against a dominant trend. So instead of taking the risk of being bear trapped, how about allowing the breakout to happen?And then once the price moves down,with downtrend still intact, wait for price to drop a bit and then you make your sale. Let’s see an example of retracement in action.
As you can see from the GBP/USD graphic, the downtrend is heading towards the support level, which is indicated by the green line. Don’t trade the initial breakout, but watch the price drop and then trade the retracement.
Keep Your Eyes Closely On Two Candlesticks After Breakout.
Keep your eyes closely on two particular candlesticks after the initial downtrend break. Why?Because two things hit these two candlesticks -Loss of momentum and bullish reversal. If these two conditions exist, scream BEAR TRAP! You may also want to start heading for the hills with your profits or put a stop loss to save potential blushes. Let’s take a look at the first graphic again.
As you can see from the graphic, the bear trap has triggered a major bullish reversal after the initial breakout.The naive bears were made to believe they were going to cash in massively, only for the smart bulls to drive the price up and head for the hills. These bears will be seriously hurting.
How To Trade Bear Trap
If you want to put your neck on the line to trade the dreaded bear trap, here are a few ground rules you need to keep in mind.
- Wait for the bear chart pattern to form, and then wait for the bullish signal to form.
- Buy a stop pending order at least two pips above the high of the bullish stick.
- Place your stop loss at least 2 pips below the low of the bullish candlestick. Or place it 2 pips below the low of the bear trap candlestick.
- If you want to make a profit, aim for a risk:reward of 1:3 minimum . Or use the previous swing trade high as your “take profit target”
This EUR/JPY graphic illustrates the bear trap trade. Notice the stop loss 1 below the bullish and the stop loss numbered below the candlestick with the thin end. Of course you see where to take your profit. Don’t get too greedy.
That’s as wrap for “Let’s Trade The Bear Trap.” Just like the bull trap, the bear trap creates the impression of a major trend only to create a huge reversal, leaving naive bears holding the bag. Hopefully none of you will suffer the same fate when you come face with the bear trap this week.
Til next time take care.
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