Bear trap is a technical pattern and occurs when the performance of a stock, index or other financial asset erroneously signals a reversal of an uptrend. In this way, the trap can hide the upward trend in prices from the eyes of investors. Bear traps cause investors to open short positions with the aim of making a profit and based on predictions made about future price changes that, of course, never happened. The opposite of this phenomenon is called cow trapping. Continue with the help an essay We will study this phenomenon from the Inostopedia website.
How does a bear trap work?
A bear trap can cause market participants to expect the price of a financial asset to fall and, as a result, sell an asset or open a short position. However, the value of the asset in such a scenario remains unchanged or increases, which ultimately causes the trader to lose.
In such a situation, a bullish trader may sell the declining asset, and a bearish trader may try to take advantage of the price reduction by taking a short position; But the downtrend does not continue or reverses after a short period of time. This price return is known as bear trap.
Market participants often analyze market trends based on technical models and then evaluate investment strategies. Technical traders try to identify and avoid bear traps using various analytical tools such as Fibonacci displacements, relative strength index (RSI) and volumetric indicators. These tools help traders to understand and predict the accuracy and stability of the current price trend of an asset.
Bear trap and shorts position
The bear is actually an investor or trader in the financial markets who believes that the price of an asset will soon fall. Bears may also see the general direction of a financial market decline. A bear financial strategy seeks to profit from the declining trend in the price of an asset. The short positioning technique is usually used to implement these strategies.
Short position is one of the trading techniques in which the trader borrows an asset or related contracts from the brokerage through a margin account. The investor sells the borrowed financial assets for the purpose of repurchasing them when the price falls to a certain level. In this way, the investor is able to benefit from a reduction in the price of an asset. The risk of getting caught in a bear trap increases when a bear investor price prediction goes wrong.
Borrowing sellers are forced to avoid further losses by closing positions if the price of an asset rises. Increased demand for the asset will subsequently continue the upward trend and eventually the price jump. After the sellers borrow the financial asset needed to cover their shorts, the uptrend will slow.
If the trend of rising stock prices, currencies, indices or other financial instruments continues, a borrowing seller will face the risk of increasing losses or even a margin margin (liquidation of assets). The trader can minimize losses from bear traps by setting stop losses at the time of order registration.