A lot of people are excited about the latest Bitcoin rally after it has recently broken through a significant resistance level. A number of traders who were caught up in all the excitement forgot about all their previous experience on when to enter a trade and ended up buying at the top of the trend, only to be met with a steep decline in price shortly thereafter. They do so by falling victim to a bull trap.

Bull traps typically occur when the price makes a fake breakout above resistance but immediately reverses afterwards. The newly long traders believe that they have entered into a new bullish trend; however, they are all left holding positions that have lost money.

How Bull Traps Form

The first factor is emotional drivers. Traders' FOMO pushes them to chase prices. Greed tells them they would rather take a bad price than miss out on the move. When enough retail traders think this way, they create the fuel for the trap.

The second factor is large players. Large players like whales and institutions can create enough buying pressure to break through resistance by using strategic buy orders. They know that once retail traders see the breakout, they are going to jump on board.

How to Identify a Bull Trap: Practical Technical Indicators

As the first step towards assessing a breakout, examine how the price responds immediately after the breakout has occurred. For example, if the price was to break upward into a new resistance area and then remain in that area it would indicate a successful breakout; however if the price drops below that resistance area then that is a sign that the breakout was unsuccessful.

Long upper wicks indicate a significant rejection. They represent a time when buyers attempted to push prices higher but sellers overpowered them and drove prices back down. Furthermore, the weak candle bodies formed after breakouts signal that momentum has been lost.

Bull Trap vs. Bear Trap: What's the Difference

Bear traps and bull traps are both artificially-constructed events created to entrap traders into taking the opposite position than intended by the market. The difference between a bull trap and a bear trap is the direction of the move.

A bull trap occurs when a trader enters into a position because of a perceived breakout above the resistance level. The price then makes an abrupt turnaround and moves back below to the original resistance level trapping long-side traders inside the market.

How to Avoid Falling Into a Bull Trap

Don't chase breakouts. While this is probably the most straightforward advice to follow, it is also perhaps the most difficult to stick to! When you see a price breakout, the natural instinct is to jump on board as soon as possible. Unless you plan to use the "I'm gonna miss the move!” excuse for the price action, hold off on buying until you see confirmation of the breakout.

Use less leverage. Traders who use high levels of leverage (10x or 20x) can find themselves in a difficult situation when a small retracement happens and can result in total liquidation. When trading with less leverage, it gives you more opportunity to withstand the volatility being produced from these breakouts.

Conclusion

Bull traps are the most popular disinformation patterns in the crypto world, exploiting human psychology and exploiting emotions like Fear of Missing Out (FOMO), punishing people who act based on speculative hunches and not waiting for confirmation on their investments before making a decision.

If you can learn to recognize these types of patterns, you will be able to significantly reduce your number of trades that are made on impulse and thus eliminate buying at any given time. By protecting your capital from unnecessary risk, you are able to remain in the market longer as an investor, which will lead to improved performance in the long run through consistent and steady results; ultimately resulting in a higher percentage of winning trades.

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