A bear trap is a technical pattern and occurs when the performance of a stock, index or other financial asset mistakenly signals a reversal of the upward trend. In this way, this trap can hide the upward trend of the price from the eyes of investors. Bear traps cause investors to open positions with the aim of making a profit based on predictions made about future price changes, which of course never happen.Shorts positiondo To reverse this phenomenoncow trapCalled. Continue with helpan articleWe will investigate this phenomenon from the Instopedia website.
How does a bear trap work?
A bear trap can cause market participants to expect a decrease in the price of a financial asset and, as a result, sell the asset or open a short position. However, the value of the asset remains unchanged or increases in such a scenario, which ultimately causes losses to the trader.
In such a situation, a trader with a bullish view (bull) may sell the depreciating asset, and a trader with a bearish view (bear) may try to take advantage of the decline in price by taking a short position; But the downward trend does not continue or reverses after a short period of time. This price reversal is known as a bear trap.
Market participants often rely on technical patterns to analyze market trends and then evaluate investment strategies. Technical traders try to use various analytical tools such as Fibonacci retracements, relative strength index (RSI) and volume indicators, identify bear traps and avoid them. 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
A bear is actually an investor or trader in the financial markets who believes that the price of an asset will decrease soon. Bears may also see the overall direction of a financial market as bearish. A bearish financial strategy attempts to profit from a declining trend in the price of an asset. Usually, short position technique is used to implement these strategies.
A short position is a trading technique in which a trader borrows an asset or related contracts from a broker through a margin account. An investor sells borrowed financial assets with the aim of repurchasing them when the price falls to a certain level. In this way, the investor is able to profit from the decrease in the price of an asset. When a bearish investor’s bearish forecast turns out to be wrong, the risk of being caught in a bear trap increases.
Short sellers have to avoid further losses by closing positions if the price of an asset rises. The increase in demand for the purchase of the mentioned asset subsequently causes the continuation of the upward trend and ultimately the price jump. After short sellers buy the asset they need to cover their short positions, the asset’s uptrend will decline.
If the price of shares, currency, index or other financial instruments continue to rise, a borrowing seller will face the risk of increasing the amount of loss or even a margin call (asset liquidation). The trader can minimize the losses caused by bear traps by setting the loss limits (stop losses) at the time of placing the order.