Today we start our three-part series on false break strategies by saying “Trade The Bull Trap.” No, the bull trap is not meant to trap live bulls. However, the bull trap is set up for a different kind of bull – the naive buyer on the forex market. Sometimes, buyers are easily sucked into an uptrend,thinking it’s safe to enter a trade. Then,much to their shock and horror, the bears springs out of nowhere and drag the price down, leaving the bulls with the tails between their legs. That’s what the bull trap does to naïve bulls. It lulls them into a false sense of security, and then pulls their legs from underneath them.
So we’re going to do a few things today. We’re going to find out what a bull trap is all about. Then we’ll look at three bull trap patterns you need to know about. And finally, we’ll learn how to avoid the bull trap.
But first things first:
What Really is a Bull Trap?
Well, a bull trap is a contraption set up for naïve bulls in the uptrend. You see,the price surges through or breaks through the resistance barrier and heads for the hills so to speak. The sad part about this sordid mess is that naïve bulls, looking to make a quick buck fall for this sucker punch. They’re like “hmmmmm………The market looks very promising .How about we cash in right now while the iron is hot?” Sounds like a good idea right? Well unfortunately for the naïve bulls, the uptrend like a Boeing 747 running out fuel across the Atlantic Ocean.
Then the unthinkable happens. The bears burst out of the woodwork and drag the price down. The price drags down leaving the bulls literally holding the bag. Not to mention the fact that all their stop loss entries take a major hit as a result of this huge reversal.
The question we should be asking ourselves is:
Who Is Behind This Carnage?
Well,it turns out that the main culprits are big time professional traders in a desperate search for cash to fund their huge trades. They basically say to themselves” How about setting up our rookie traders for a huge crash? We make them believe an uptrend is about to start and then boom! We set the trap on them and then we cash in on the price drop. This may sound sadistic to some of you out there,but it seems perfectly legal. In fact, you can also cash in on the bull trap.You just need to keep your eyes wide open as the bull trap unfolds. Let’s look at an illustration of the bull trap
This, my friends is a classic example of the bull trap in action. See how the price gives the impression of a strong uptrend,but then the bears burst out of the woodwork and drag the price down, leaving the bulls in a huge fix. I guess the moral of the story is don’t count your chickens before they ‘re hatched.
Three Bull Trap Patterns You Need to Beware of
I assume you are all aware of the famous sign “Beware of the Dog”. Mentally you should also have the sign”Beware of the Bull Trap.” As a matter of fact, I’m going to show three bull trap patterns you need to beware of out there on the market.
Bull Trap#1- Candlestick Break and Close
This bull trap pattern shows a price break at resistance but then the bearish downtrend resumes almost immediately.
Bull Trap#2 – Candlestick Breaks Resistance Level But Closes Below Candlestick
This bull trap pattern shows an uptrend breakout at the resistance level but the bears eventually take over and head for the valley.
Another classic case of a bullish breakout at the level of resistance, and the bears taken over. Once the first two candlesticks kick in downwards, that’s the beginning of the bull trap.
Now that we know how deadly the bull trap can be, I guess the most obvious thing to do is to learn:
How To Dodge The Bull Trap
1. Place a Large Enough Stop Loss
Place a large enough stop loss to avoid getting caught in the bull trap. The trick is knowing high the price will climb before it crashes.
2. Only Trade In The Direction of the Trend
You’d be better off if you only trade in the direction of the trend. Because 90% of the time if the breakout does not follow the trend, it can only mean one thing-BULL TRAP! And you sure do not want to be at the mercy of those smart traders do you? If you still aren’t sure about how to trade trends, do me a huge favor, and visit myTrade Trends With Price Action Analysis post.
3. Trade The Retracement.
While you’re considering other options, you may want to consider trading the retracement In case some of you have forgotten, a retracement is a temporary reversal of the prevailing trend. With that in mind, just wait for the price to temporarily drop, and then you place your buy order.
Keep Your Eyes On The Next Two Candlesticks After Breakout
If you really do not want to get caught in the bull trap, keep your eyes on the next two candlesticks after breakout. Why? Because these two candlesticks trigger the bull’s loss of momentum and the unfolding of the dreaded bull trap. So here is what you need to do when these two scenarios occur
- Take all your profits and head for the hills. You do not want to be laughing at the wrong end of your mouth.
- You can also put in a stop loss to trail stop your trade and gather whatever is left of your valuable profits
- Or use some of your profits to move stop loss to break even point or move stop loss to lock in some profits. This is a very risky option, so you may have to think long and hard about this.
Let’s see a classic graphic of what I’m referring to.
As you can clearly see from the graphic, The bulls have been sucked into this hot uptrend. But notice the momentum stall once the first two bearish candlesticks kickstart the downtrend. The bull trap alarm should be ringing in your head, the moment you see this scenario unfolding.
How To Trade Bull Trap
If you want to sink your teeth into trading the bull trap Here are a few ground rules you need to follow
- Watch out the price surge towards the resistance level and see if you can spot a bull trap pattern.
- Upon spotting the bull trap, place a stop pending order at least two pips below the low.
- Next place a stop loss at least two pips above the high
- But if you want to make a profit, either aim for the previous swing price at the lower low or risk reward of at least 1:3
Well that’s a wrap for “Trading The Bull Trap”. The bull trap can be a huge tease if you fall for it easily. But it can be profitable if you know what you’re doing. Next time we’ll touch on trading the bear trap. Isn’t it great to turn the tables on the bears?
Til next time take care.
Opening Of Live Forex Trading Account
If you’re looking to open a live trading account sign up with EasyMarkets.