Here's how to avoid getting caught in a 'Bear Trap' while trading

Simply put, a bear trap is a technical pattern that occurs when the performance of a stock or an index wrongly signals a reversal of a rising price trend. At times, such reversals instead turn into follow-up buying, thus trapping the sellers in their short positions. The psychology behind this whole process is called a “Bear Trap”. 

A breakout stock typically draws buyers, and, because of the uptrend, volumes get added. That said, there are traders and investors who mindfully watch such a move to capitalise on the profit booking move or a negative reversal. On several occasions, such a strategy has given high returns, but the conviction for such a move needs to be firm.

'Bear Trap' is, in other words, a false indication of a negative reversal which appears to be weak with corrective moves that lure short-sellers, only for the prices to then see a steady recovery. It is rare to identify a perfect reversal that yields substantial returns. In many cases, participants are forced to exit in massive losses. CLICK HERE TO VIEW CHART

How to avoid the 'Bear Trap'

• Always validate the reversal on weekly and monthly charts; a correction on the daily chart might not give a firm affirmation that materializes into profits.
• In a reversal, the perceived weakness needs to possess a few significant indications like a Gap down, price consistently falling after hitting a higher range or a level, indicators like Relative Strength Index (RSI) and Moving Average Convergence Divergence (MACD) showing overbought conditions or moving averages showing slower rise.
• Stability in volumes is crucial for any reversal. Volatility indicates uncertain sentiments which might not turn in bear's favour.
• Avoid stocks which might be climbing new highs, such as 52-week high or monthly high.
• Unless a stock shows breakdown underneath the previous support level decisively, avoid it.
• A sudden jump in stock price may attract immediate weakness; swing trades are normal. But, always see that swing trades display weakness for the next two to three sessions.  
• Never look for reversal on the intraday scale, it could be hourly chart, 30 mins, 15 mins, 10 mins, or 5 mins. These signals may not always give proper warning signs.

Effect of 'Bear Trap' on trading

As one gets stuck in a bear trap, the basic trading skills start to diminish. To build stable profit in trading, consistency and ability to digest losses are a must. Every trade might not give the perfect turnaround, as predicted; in such a scenario, exiting even at a minor loss is a viable option.

Secondly, while taking a contra call, look for minimum gains as the trade is against the trend. Betting on a contra call is not a bad decision, however, if it goes wrong, then retrieving those losses becomes a tough task.

Trading is all about developing strategies and building trading principles. The most notable features of a trader are patience and calmness and a bear trap destroys both.

Lastly, instead of considering a larger gain from a stock, it is better to have a safe trade that can gradually broaden one’s trading skills.