What Is Bull Trap?
Also known as: Bull Trap Pattern, False Breakout
In short
A bull trap is a misleading price move in which the price breaks above an important resistance level, giving the impression that the rally will continue, but soon falls again, causing losses for investors who bought or opened long positions on this breakout.
A bull trap usually develops like this: the price rises above a resistance that has not been broken for a long time. This breakout triggers new buying and long positions in expectation of a rally, and also triggers the stop orders of those who sold short. However, there is no buying power to sustain the rally; profit-taking sets in and the price falls back below the resistance. At this point, the stop-loss orders of new buyers and the liquidation of leveraged long positions can accelerate the decline.
Bull traps are especially common in short-lived recoveries in bear markets. For example, when a coin that has been falling for a long time breaks an important resistance, comments that the bottom has been seen spread, but within a few days the price drops to new lows. Breakouts that occur on low volume and sudden news-driven rallies are riskier in this respect.
To tell whether a breakout is real, analysts look at trading volume, whether the price closes above the resistance, and whether the broken resistance is tested as support. Signals in indicators such as the RSI that conflict with the price (bearish divergence) are also considered a warning sign. Using a stop-loss can help limit the loss in case of a trap. The opposite of a bull trap is a bear trap.
Last updated: · This content is for information purposes only and is not investment advice.