There are many dangers inherently found when investing or trading in the equity markets. But what increases your risk is not knowing how to identify or avoid the many traps purposely set up to take your money. One such trap is the Bear Trap in Stocks.
Markets move higher because of an imbalance between buying and selling pressure. For example, when there are a lot of people wanting to buy but no sellers to match them at the current price. In this instance, to attract sellers, the buyers will raise their bids, (the price they are willing to pay for the stock). The higher price is likely to attract sellers to meet the demand.
The problem is that when anyone buys a stock, they automatically become selling pressure on that stock. Remember, once you own a stock, you only profit from it once you sell it (unless you earn dividends on the stock). So, if too many people buy the stock, it will diminish the buying pressure and increase the potential selling pressure.
What is a Bear Trap?
In order to create more demand and get the prices of stocks to move higher, institutions need to shake out the amateur/novice traders. They do this by pushing prices lower to make it seem like the stock or the markets are becoming bearish. The fear of losing their small profits, or of losing money in general, will force the novices into selling their stocks. Once a trader has been stopped out or tricked into selling their stock, they will frequently jump back in if they see the prices moving upwards beyond the price that they had originally bought in. This, in turn, creates more demand and drives the prices higher just as the institutions wanted.
When to Expect a Bear Trap
Institutions buy stocks at wholesale prices, usually after they drop. This will cause downtrends to reverse and markets to rise. This is the best time to buy, but many amateur and novice investors and traders wait and buy once they see that prices are already bullish. Worse yet, many people are taught to buy breakouts and chase price as it moves higher. This signals to the institutions that it may be time to set the bear trap on the stock. When you see an increase of volume accompanying a breakout in price, a bear trap is usually not far off.
Bear traps on stocks can also be found on intraday charts. The same setup is usually observed, prices breaking out to fresh highs where institutions will sell or short sell to the novices buying the breakout. This halts the upward movement and scares the novices into panic, causing them to sell their stock or triggering their stops. Once the price drops into demand, the institutions buy to cover their shorts and send prices higher where novices will jump back in for fear of missing out.
How to Trade a Bear Trap
To be profitable in the markets, you want to trade like a professional. Bear traps on stocks are usually set in the same circumstances as those described above. Now that you know what the professionals are looking for to set the bear trap and how they trade them, you could trade and invest right alongside of the smart money.
If you follow OTA’s Core Strategy, you have a set of rules and will trade and invest with the dominant trend and quality demand and supply zones. There are also Bull Traps that can be a danger or an opportunity for traders. To learn more about the Core Strategy and/or other market traps and opportunities, visit your local Online Trading Academy Center today.