Have you ever gone Short only for the market to immediately turn against you and hit your Stop Loss?
What’s worse is that once your Stop Loss has been hit, the market starts going back down again.
If you have experienced this, then you’ve most likely fallen into a Bear Trap.
So the question is…
How do you avoid Bear Traps?
Is it even possible to avoid Bear Traps?
And how do you take advantage of this to trade bear Traps?
In this post, I will share with you what exactly goes on behind a Bear Trap…
How to accurately spot a Bear Trap…
And how to take advantage of it by trading the Bear Trap.
What Exactly Is A Bear Trap?
Have you ever heard traders say that they feel like the market is targeting them?
I’ve heard this quite a few times from new traders who just read a few blogs and start opening a trading account to trade for the first time.
So is it true that the market is targeting them?
In a way, it’s true to a certain extent…
But it’s not exactly the market that’s targeting them.
It’s the big institutional players.
However, the big institutional players aren’t targeting them as if they know who they are.
The institutional players are targeting particular setups that have become so popular that it has become somewhat ineffective.
So what exactly is a Bear Trap?
A Bear Trap is a deliberate move by the big institutional players to trap traders into thinking there is a Short trade.
They lure you into their trap by making you think this is a Short setup…
And once you’re in the trade, they start buying up forcing you to get stopped out.
If you’re thinking this isn’t possible, then think again…
Because this is what’s happening in the markets every single day.
How do I know?
I’ve seen it time and time again when I was a prop trader.
In fact, we sometimes do it when we see the right opportunity.
And that’s how the big institutional players trade the markets.
Why Do Bear Traps (or Bull Traps) Happen?
Trading is a zero-sum game for the most part.
In order for a trader to profit, another has to lose.
An analogy is that trading is like playing poker.
You have to outplay your opponents in order to win.
For example, in the past, poker legends like Doyle Brunson would just play only the top hands and play it very tight to win.
So by being disciplined and playing only strong hands like Ace-King to Ace-Ten, and high pairs, it was more than enough for him to win.
That was a time when people didn’t really know how to play power and played all sorts of different hands called “junk hands”.
These junk hands do not have a high probability win rate.
However, in this day and age, everyone now knows of the strategy.
When that happened, lesser players were playing these junk hands.
Poker players became more educated as more books on how to play poker get published.
This resulted in more people playing these strong hands only.
And that made the game tougher to win because everyone was playing the same way.
So how do the top poker players win these days?
They prey on those that play just these tight hands.
Because they know that they only play tight hands, it becomes very easy to read their plays and outplay them.
So if I know you only play top hands like Ace-King, and the board comes out low cards, it would be easy for me to get you to fold your hand by bluffing a bet.
And of course, as more and more people realize that they are getting bluffed because they are being put on strong hands, they evolve their gameplay as well.
This ultimately makes this game extremely psychological and tough.
That is the same with trading.
As more and more traders get more knowledgeable on the types of setups that they should trade, the big institutional players will know where traders are getting into a trade.
And with that knowledge, they plan traps which we call Bull and Bear Traps.
Can You Avoid A Bear Trap?
So is it possible to avoid a Bear Trap?
The answer is yes, to a certain extent.
To know how to avoid a Bear Trap, you must first understand how a Bear Trap happens in the first place.
First of all, to do an effective Bear Trap, the market cannot have too many big players.
That’s because to do a Bear Trap requires the big institutional players to move the market.
And to move the market requires a huge amount of funds.
So if there are many big players in the market, they run the risk of fighting each other which is not what the big players want.
It will become too expensive and both sides may not necessarily win.
So they only target the markets where they can easily move the market.
And that’s with illiquid markets.
When a market is illiquid, it allows for these big institutional players to move the market however they wish.
So the first way to avoid these Bear Traps is to avoid illiquid markets.
And that’s why in the Forex Market, you want to avoid the exotic pairs if you’re planning to do intraday trading.
For example, when I was a prop trader at the equities desk, all of us would avoid illiquid stocks.
That’s because, in illiquid stocks, there’s usually only one or two big players controlling the stock.
These big players will have free reign in the stock.
That means they could move the stock intraday very easily.
So if you trade that, they would be baiting and trapping you all day long.
And that leads me to the second point…
For a Bear Trap to happen, there needs to be a “bait” before the big institutional players can trap.
So what is this bait?
It’s the trade setup.
For example, there is the saying that a trading system becomes ineffective if everyone trades it.
And that is true to a certain extent.
For example, the turtle’s trend-following system is no longer as effective as it used to be because it became too popular.
While there are people that claim that it is still working for them, it’s widely known that the profitability has drastically dropped because it is now the target of algorithms.
Even Richard Dennis stopped trading altogether because the very trading system that he taught to the turtles was no longer as profitable as it used to be.
After two public commodity funds that he had launched lost more than 50 percent of its value, he started to focus on his political career.
When a trading setup becomes too popular, it becomes the target of big institutional players.
So you want to avoid the over-popular trading strategies.
How A Bear Trap Happens
So are you curious to know how the big institutions bait and trap traders?
I will show you from an order flow perspective because this is something that happens on a daily basis when I was at the prop firm.
So first of all, to bait traders into a Bear Trap, the big players will manipulate the Bids and Offers to let you think the market is weak.
For example, when you see the Depth-of-Market (DOM), you will see this:
If you noticed in the DOM above, the Offers are so much bigger than the Bids.
Now, just purely by looking at this DOM, chances are you wouldn’t want to go Long at all right?
That’s because the Offer is so much thicker indicating there’s more selling pressure than buying pressure.
But is that necessarily true?
This is where the big players are baiting you to go Short.
So let’s say you see a setup on the charts that looks ripe to go Short, and you hit the Bid.
Now you’re Short and you see this:
You noticed the Bid got even thinner and the Inside Offer got even thicker.
This made you feel even more confident about your Short trade.
Then as you watched the transactions that are happening, you noticed an order of 50,000 shares sold at 1.49.
So theoretically, 1.49 should flip and become Offer.
But instead of turning Offer, it remained Bid.
The DOM now looks like this:
After 50,000 shares got sold at 1.49, instead of it flipping to become Offer…
It remained as Bid and now with an increased size of 50,000 compared to the 20,000 before.
Then again, another transaction went through at 1.49 for 70,000 shares.
This time surely 1.49 should flip to become Offer right?
But no, it remained Bid and the DOM looked like this now:
1.49 remained Bid with an order of 30,000 shares still.
So what on earth is happening?
The answer is that you have been baited.
The big players have placed an Iceberg Order at 1.49 to secretly buy up a position.
And they deliberately made the DOM look like it was strong on the Offers so that people seeing this would sell into them.
As you sell into them, they are building their Long position.
This is how institutional players build up their position.
Because their size is so big, they can’t reveal it on the Order Book.
For example, if you see an order on the 1.48 Bid for 2,000,000 shares, chances are that you will want to front-run that order and place your buy order at 1.49 or even just lift the Offer 1.5o right?
That’s why the institutional players have no choice but to build up their position discreetly.
And once they have built up a big enough position, they will make their move like this:
Suddenly you will notice the Offers become so thin and the Bids become so thick.
Why is that so?
That’s because they simply pulled their orders from their Offers and then queued on the Bids.
When you see this, suddenly you realize you’re caught Short and you and the other traders start queuing on the Bids too to try and hopefully get out at breakeven or a small loss.
But then, the big players won’t allow that because they just loaded up a big position at 1.49 and they want to make money.
So they sweep up the next few levels like this:
You and the other traders who can no longer take the pain of the open loss decide to hit the Offer to get out of your position.
And this further fuels the move upwards.
This is a Bear Trap at its core.
The same thing is happening in the Forex Market as well but on a grander scale.
So now that you know what a Bear Trap is, how do you take advantage of this in the Forex Market?
How to Take Advantage of A Bear Trap
There are three things in common about Bear Traps:
- They break lows then immediately bounce back up.
- They target obvious Stop Loss placements then reverse.
- They are limited in how far they can push the market.
Now, for a downtrend to happen, the market has to make lower lows and lower highs like this:
So what many traders will do is when the market breaks a swing low, they will go Short anticipating the market to go lower.
In the chart above, you can see that the market is forming lower lows and lower highs as it goes steadily downwards.
On the right-hand end of the chart, many traders might either go Short at the long bearish candlestick bar…
Or they might pyramid and increase their Short position there.
And as you can see in the chart above, after the market broke that last swing low, it shot up with one big candlestick bar.
This is usually a sign of a Bear Trap.
Chances are that the big players have been building up a Long position at around the 108.30 level…
And once they have built a big enough position they sweep up the market to force traders out of their Short trades.
You can see that after that big bullish candlestick bar, the market started to form small candlestick bars and just go sideways.
This shows the volatility has dropped.
And that’s most likely because the big players have unloaded their positions and have taken their profit.
So the market’s volatility goes back to normal.
With this knowledge in mind, here are two trading strategies to take advantage of Bear Traps…
Which means to trade WITH the big institutional players.
Two Bear Trap Trading Strategies
Here are the two Bear Trap trading strategies:
- The Bear Trap Pullback
- The Bear Trap Breakout
1) The Bear Trap Pullback
They will go Short at the break of the low of the bearish candlestick and then place their Stop Loss right above the high like this:
The big players in the market know this is what you’re looking for and will push the market up to get you stopped out and then resume the downtrend like this:
Knowing this, we can use this to our advantage by trading with the big players.
To do that, we want to first wait for a break above the previous swing high (thus forming a higher high), and then look for a bearish divergence using the Stochastic Oscillator.
If there is a bearish divergence, then we will go Short once the market closes below the 20 EMA.
So here’s what we are looking for on the charts:
Let’s take a look at a chart example:
In the chart above, you can see that the market is in a strong downtrend.
At one point in the chart, the market did a pullback to the 20 EMA and then formed a Dark Cloud Cover.
This is a bearish candlestick pattern and many traders would have gone Short at the break of its low.
And they would have placed their Stop Loss at the red line marked on the chart.
Just as they went Short, the market went back up to take out their Stop Loss and formed a higher high.
These traders that went Short, were caught in a Bear Trap.
At this point, where the market formed a higher high, the Stochastic Oscillator is showing a lower high.
This shows us there is a bearish divergence.
Once the market closed below the 20 EMA, that’s our signal to go Short.
2) The Bear Trap Breakout
The second Bear Trap trading strategy is where the big players catch traders who would go Short at the break of new lows.
Here’s where most traders would go Short:
This is where the big players like to catch Short traders and push the market up.
So, to take advantage of this, we want to go along with the big players to go Long on this trade.
To go Long, we are waiting for the market to break the swing low and then go back up to form a lower low.
At the same time, we also want to use the Stochastic Oscillator to identify a divergence to give us a higher probability of the trade working out.
So what we are looking to see is for the market to form a lower low, where the market just breaks slightly below the previous swing low…
And for the Stochastic Oscillator to show a higher low indicating a divergence like this:
To go Long, we wait for the market to close above the 20 EMA.
Let’s take a look at a trade example:
In the chart above, you can see that the market is in a downtrend from the left-hand side.
Then as it went lower, it broke below the swing low with a long bearish candlestick bar.
This is the trigger for many traders to go Short.
Right after that, the big players pushed the market up trapping the traders that went Short.
At that point, the market formed a lower low, and the Stochastic Oscillator was showing a divergence.
Once the market closed above the 20 EMA, this is our trigger to go Long.
Whether you like it or not, believe it or not, the market is being manipulated at times.
And these manipulations are called Bull and Bear Traps.
However, what that means is that it also presents us with good opportunities to profit from the market.
And that’s because we always want to trade with the big players.
So when these big players make their move, we want to go on that ride with them.
What I’ve shared with you in this post are some of the ways to identify when these manipulations called Bear Traps are happening.
With this knowledge, you can now trade with the institutional players.
Now I have a question for you…
Have you ever been caught in a Bear Trap before?
Let me know in the comments below.
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