What is a bear trap in trading and how to avoid it?
As a difficult proposition for novice traders, a bear trap can be recognized by using charting tools available on most trading platforms and demands caution to be exercised.
In most cases, identifying a bear trap requires the use of trading indicators and technical analysis tools such as RSI, Fibonacci levels, and volume indicators, and they are likely to confirm whether the trend reversal after a period of consistent upward price movement is genuine or merely meant to invite shorts.
Any downtrend must be driven by high trading volumes to rule out the chances of a bear trap being set up. Generally speaking, a combination of factors, including the retracement of price just below a key support level, failure to close below critical Fibonacci levels and low volumes, are signs of a bear trap being formed.
For crypto investors with a low-risk appetite, it is best to avoid trading during abrupt and unsubstantiated price reversals unless price and volume action confirms a trend reversal below an important support level.
It makes sense to retain cryptocurrency holdings during such times and avoid selling unless prices have breached the initial purchase price or stop-loss level. It is beneficial to understand how cryptocurrencies and the entire crypto market react to news, sentiments or even crowd psychology.
Practicing this can be much more difficult than it seems, especially when one factors in the high volatility associated with most cryptocurrencies in trade today.
On the other hand, if you do want to profit from the momentum reversal, it is better to get into a put option rather than short-selling or becoming a long seller in the underlying cryptocurrency. This is because short-selling or selling a call can expose the trader to unlimited risk if the cryptocurrency resumes its upward trend, which isn’t the case if one opts for a put position.
In the latter strategy, losses are limited to the premium paid and have no bearing on any long crypto position being held from before. For long-term investors looking for profit without high risks, it is better to stay away from trading during a bear trap altogether.