What is a bear trap, and how does it work? A bear trap is a type of planned but controlled selling designed to create a short-term drop in asset prices. In markets that deal with assets such as equities, commodities, bonds, or even cryptocurrencies, inexperienced traders are frequently caught off guard by price volatility.
Price reversals, which can perplex even the most seasoned traders, are a surefire way to lose money for those who rely on daily or intraday charts. This emphasizes the need of establishing indicators of a phony reversal before resuming the underlying trend in order to avoid being taken advantage of.
Extreme volatility might even entice short-term traders to make many transactions in order to time the markets, resulting in significant losses for most and their confidence or belief in the underlying asset.
In an ascending market, a substantial drop in prices might cause turmoil and force investors to sell long-term holdings or go short on the underlying asset in the hopes of making a quick profit. This reversal, if caused by a group of investors selling in bulk, is usually brief.
This form of market manipulation is referred to as a bear trap, and it deceives bearish investors into thinking that the price reversal signals the start of a downturn and is often followed by a strong upswing.
Shorting, the act of selling an asset in order to repurchase it at a lower price later, is highly speculative during these periods of volatility and draws bearish traders to take huge risks. Because a bear trap is often immediate and brief-lived, long-term investors might be shaken by the brief selling pressure and lose some or all of their gains.
What is the purpose of a bear trap in cryptocurrency markets? A bear trap in cryptocurrency markets works similarly to how other assets work, enticing both bearish and bullish bets while often posing significant risks. A form of market manipulation that is caused by concerted efforts of a group of traders who own significant quantities of the underlying cryptocurrency, a bear trap in crypto markets is a kind of market manipulation that is brought about by concerted efforts of a group.
The coordinated selling of a token by a group lowers the price and encourages other retail investors to believe the advance is finished. Many investors may sell their assets as a result, resulting in the price dropping even more for a few hours or days at a time.
Normally, following a break below the previously set lows, these powerful trader organizations would then purchase back the sold quantities at depressed rates, triggering a strong upward surge that entangles bearish bets on a large scale.
Traders who have placed bets on a price drop will rush to buy the cryptocurrency in order to limit their losses, which only serves to push the price even higher. The trader group or bear trap setters create this gap by selling at a higher price and repurchasing all sold positions at a lower price level in order to profit from the difference without affecting how much cryptocurrency they hold over time.
Bear traps vs. short-selling Short-selling a cryptocurrency or establishing short positions through other market instruments is the precursor to creating a bear trap. Shorts on popular cryptocurrencies like Bitcoin (BTC) may be carried out using several methods, such as shorting tokens, margin trading, and trading in futures and options of the base cryptocurrency.
The use of bear options to hedge their positions in the secondary market is common among seasoned traders and institutional investors. These strategies can protect your investments if the market or trend reverses.
Shorting a cryptocurrency, for example by any of the various techniques, is a widespread practice that occurs in amounts far lower than the primary token trade volume. However, when shorting a cryptocurrency like BTC on an immoderate scale, it can result in enormous downward pressure on its price owing to an overall increase in the fear quotient.
Prices can fall below the key support levels when technical indicators such as the relative strength index (RSI) hint at a cryptocurrency entering a bear market, which may then lead to a larger sell-off driven by less-informed retail investors who want to take risk out of the equation. If this sentiment persists and prices continue to drop, it might attract even more bearish investors to put up short bets in order for big trading organizations to create a bear trap by covering their original shorts.
As a result, a bear trap begins when a number of investors sell off a cryptocurrency and ends when they either close their derivative positions or buy back their short-sold cryptocurrency holdings.
In markets like the United States, conspiring with other traders to manipulate the price of a cryptocurrency is considered unlawful and can result in the prosecution of several central authorities.
What is the difference between a bear trap and a bear flag? A bear trap can be bullish or bearish depending on how you define it. A bear trap, in its strictest sense, unsettles investors and market participants since it entails the underlying asset’s momentum changing from negative to positive before reversing swiftly to resume its upward climb.
If the asset’s value subsequently rises beyond the previous resistance level, it may be seen as a buying signal by a bullish trader. Those with a bullish attitude might use a technique called “closing puts and calls of key price levels” to generate profit over a wide price range by simultaneously selling puts and calls at key levels.
For a bearish trader, the first trend reversal might be taken as a signal to sell, necessitating careful risk-reward analysis and extreme caution in order to avoid losing money. The moment for establishing a short position must be well planned; this makes trading a bear trap quite difficult for a bearish forex trader.
A poor recognition of the resumption of an underlying bullish trend can be dangerous for bearish bets, especially those that are short-sold or leveraged.
How can you tell if a bear trap has been laid? A bear trap might be recognized by utilizing charting tools accessible on most trading platforms, which necessitates caution. In most situations, identifying a bear trap entails the use of trading indicators and technical analysis tools such as RSI, Fibonacci levels, and volume indicators, and they are likely to verify whether the trend reversal following a period of continuous upward price growth is genuine or simply intended to attract short bets.
To exclude the possibility of a bear trap, any downward trend must be driven by high trading volumes. When looking for bear traps, there are a variety of criteria to consider, including the retracement of price just below a key support level, failure to break below critical Fibonacci levels, and low trading volume.
It’s not advised to trade during abrupt and unproved price reversals unless price and volume action confirm a trend reversal below an important support level for crypto investors with a low-risk appetite.
It makes sense to keep cryptocurrency assets for as long as possible during market downturns, and to sell only if the price has exceeded or surpassed the purchase price or stop-loss level. It’s important to understand how cryptocurrencies and the entire crypto market work in terms of news, sentiments, and even crowd psychology.
It may appear to be easier than it is in practice, especially when one takes into account the high volatility prevalent in most cryptocurrencies today. However, if you want to profit from the momentum reversal, a put option rather than short-selling or becoming a long seller in the underlying cryptocurrency is preferable. This is because short-selling or being a long seller on an upside scenario might expose the trader to limitless risk if the cryptocurrency resumes its climb, which isn’t the case if he or she chooses a put position.
In the second strategy, losses are confined to the premium paid and have no impact on any long crypto position that has been established before. For long-term investors seeking for profit without a lot of risk, it’s best not to trade during a bear trap at all.
If you are an Australian crypto trader, then the Crypto Tax Calculator Australia is definitely a tool you need. It’s easy to use and can save you time and money when it comes to preparing your taxes. The calculator offers a variety of affordable plan options, as well as comprehensive reports that can be printed off and used as evidence when lodging your taxes. In addition, the calculator contains all the latest information on crypto coins and their performance, so you can ensure that your calculations are accurate.
Try our crypto calculator today!