Crypto assets are investment instruments that are increasingly popular and are in great demand by the public today.
One of the well-known crypto assets is Bitcoin. However, like other investment instruments, crypto assets also have risks that investors must consider.
One of the risks to watch out for is the bull trap. This article will discuss a bull trap and how to avoid it. Come on, let’s see.
What are Bull Traps?
A bull trap is a term in the investment world that refers to a situation when the price of a crypto asset or stock rises rapidly after a long period of decline.
This price increase can trigger investors’ belief that prices will continue to rise, and they will start buying the asset.
However, it turned out that this price increase was only temporary and not sustainable.
After reaching a certain point, the asset’s price starts to fall again, and the investors who recently bought the asset are disappointed because they bought it when the price was already very high.
The difference between the Bull Trap and the Bear Trap
Bull and bear traps are behavior patterns common in the crypto market and in all financial markets.
Both occur when the price of an asset makes such a significant movement that traders react by opening positions in the direction of the price movement.
But then the price reversed, resulting in losses for traders caught in the trap.
The difference between a bull trap and a bear trap is the direction of price movement that produces the pattern.
A bull trap occurs when the price of an asset rises significantly, enticing traders to open long positions, but then the price drops back to its previous level or even lower. This makes traders who open long positions lose money and fall into the “bull trap.”
Meanwhile, a bear trap occurs when the price of an asset drops significantly, attracting traders to open short positions, but then the price rises back to the previous level or even higher.
This makes traders who open short positions lose money and get caught in the “bear trap.”
In both cases, traders caught in the trap can incur huge losses if they do not understand this pattern and have poor risk management.
Therefore, traders must study these patterns and develop appropriate strategies to avoid these pitfalls.
Bull trap example
As a simple example, try to imagine the price of ABC’s stock, initially at $ 10 per share. Then you get good news about company ABC which is improving its financial prospects, so you, as an investor, start buying lots of ABC shares.
ABC’s stock price rose significantly and reached $ 15 per share quickly.
Investors who saw this increase began to think that ABC’s share price would continue to rise and decided to buy more.
However, suddenly there is bad news about ABC company that they will experience big losses shortly.
This bad news has caused many investors like you, as novice traders, to panic and start selling ABC shares earlier.
In a short time, ABC’s stock price fell sharply back to its initial level of $10 per share or even lower.
Investors caught in this bull trap became very worried and lost big because they bought ABC stock at too high a price and could not get out of the market promptly.
This example shows that a bull trap occurs when investors are trapped in market euphoria and optimism, so they continue to buy in the hope that prices will continue to rise. Still, in reality, prices cannot continue to rise without correction.
Therefore, it is very important for novice traders always to be careful and consider the risks before making investment decisions.
How to Prevent Bull Trap and Bear Trap
Although there is no guarantee that you can completely avoid the bull or bear trap.
There are several ways to reduce the risk of being trapped in these conditions in crypto assets.
The following are several ways this can be done, including:
1. Do some research before deciding to buy crypto assets
Find out about the project, development team, and potential uses of the crypto asset.
Avoid buying just driven by hype and a desire for quick profits.
Use the Relative Strength Index (RSI) approach, a technical indicator that can be used to measure the strength of the price trend of a crypto asset.
To avoid bull traps and bear traps in crypto, you can use RSI by:
- Understand how to read the RSI indicator and know a value above 70 is overbought.
- Monitor price trends of crypto assets and watch out for if the RSI approaches or exceeds a resistance level, which could be a sign of a bull trap.
- Look for divergences between the RSI and crypto asset price trends, where if crypto asset prices rise but the RSI decreases, then this could be a sign of a bull trap.
2. Take advantage of trading orders (Stop Loss Orders)
The next way to prevent it is to take advantage of trading orders (Stop Loss Orders) commonly used by traders to limit losses on opened trading positions.
A stop-loss order method can help you reduce the risk of greater losses when caught in a bull or bear trap.
- Always monitor trading volume over time to see if there is a significant increase in trading activity. Suppose the trading volume increases significantly when the price of the crypto asset increases.
- Refrain from relying too much on news and opinions on social media or discussion forums.
- Avoid buying or selling crypto assets because many people are talking about it. Always do your research and analysis before making an investment decision.
- Stick to a pre-made investment plan and be okay with changing it just because of FOMO.
- In volatile market conditions, it is important to have a mature investment plan and be disciplined in following it.
The bull trap is a risk that every investor should know.
However, by carefully analyzing and paying attention to fundamental and technical factors.
As well as limiting investment risk, investors can avoid both bull and bear traps and achieve their investment goals successfully.