When the market seems to be heading downwards, traders begin selling their assets in order to avoid losing money. Instead of continuing its downward trend, the market reverses abruptly and starts to rise, trapping bearish traders that sold their assets anticipating a further decline.

Market manipulation by large players, such as hedge funds or institutional investors, is one of the most common reasons for bear traps. They can create an artificial bearish mood by selling large amounts of a certain asset. This causes small traders to panic, and sell as well.

After these smaller traders sell their assets, large players will start to buy them back, and this drives the market up, causing the bearish traders significant losses.

Main Points: 

• It is difficult to predict whether a downward trend will continue or turn into a trap.
• From a trading standpoint, traders need to be cautious about the size and duration of their positions if an uptrend is expected.
• Any asset market can be a bear trap, whether it’s equities, futures, currencies, bonds, or bond markets.
• A bear trap is a technical indicator that cannot be relied upon to predict a reversal of the market from an upward trend into a downward trend.
• Bear traps are used to catch unsuspecting sellers.
• A bear trap is a downward correction in a bullish trend.
• A beartrap is the opposite of a ‘bull trap.

How Does Bear Traps Work?

When traders intentionally sell large quantities of an asset to drive the price down, they create a bear trap. The false impression that the market is declining leads other traders to think the asset’s value is decreasing and sell their positions.

The traders who set up the bear trap will begin buying large quantities of the asset, at the artificially reduced price. This increases demand and drives the price up.

These are some ways in which bear traps can work:

1. False signals– Traders will create false signals to indicate that the market will drop. These signals can include a sudden rise in sales volume or a sharp fall in prices. These signals are intended to encourage investors to sell assets, thereby lowering the price.
2. Spreading FUD– Fear, Uncertainty, and Doubt (FUD) is a common tactic used by traders to create bearish markets. Traders spread rumors and news reports that claim the markets are about to crash. This causes investors to panic, and they sell their assets.
3. Sell Off– Traders sell off a large amount of an asset, which causes its price to fall. It creates a cascade effect as other investors panic and begin to sell their assets, causing a major drop in market value.
4. Short selling– Traders may also use short sales to set up a beartrap. Short selling is when a trader buys assets at market value from another investor and then sells the same assets back to that investor. The trader waits until the asset price drops before purchasing it at a lower rate, returning the asset to its original owner and pocketing any difference.

A bear trap is an artificial downward trend created by traders in order to gain profit. Investors need to be aware of the tactics in order to avoid being caught up in a beartrap.

How to identify a bear trap

Bear traps are often difficult to detect. Bear traps are usually only visible after the trade has failed and there’s been a short squeeze.

Bear traps are usually short-lived but they tend to be characterized by a sudden increase in volume. The credibility of a move is increased if the price of a security moves in conjunction with an increase in volume.

You should always plan and do research before trading. You can do this by combining fundamental and technical analysis to understand an asset better.

It is unlikely that the fundamentals of an organization will change in a matter of days. The technical picture, however, can change quickly. You will probably be focusing on this when you identify a beartrap.

The technical analysis offers a wide range of indicators that can be used to identify key resistance and support levels. These indicators include the Fibonacci retracement tool, moving average (MA), moving average convergence/divergence (MACD), and Bollinger Bands.

Bear trap example

Bed Bath & Beyond has been caught in several bear traps. Bed Bath & Beyond had weak fundamentals in 2022. Its balance sheet was dominated by debt of around $3 billion and little cash. Short selling was possible because investors questioned the company’s ability to continue and its business was struggling.

Bed Bath & Beyond shares have experienced several sharp rallies. These could be viewed as bear traps. The biggest was around the middle of 2022. The stock price fell in June and July of that year.

In August, however, the share prices began to rise – at first slowly, then rapidly. It rose from $5 to $23.

In this example, both the share price and volume accelerated. These increases may have been a warning sign that a trap was about to form. In January 2023, the share price plunged to $1.66.

For those who were short on the market, this sell-off came too late. As the share price rose and losses became unmanageable, many were forced to cover. They were caught in a bear trap.

The share price has managed to rally despite the weak fundamentals of the firm on several occasions. The technical analysis can help identify bear traps like this.

How to escape a bear trap

Stop loss orders can help you manage your risk and avoid bear traps. Stop orders come in several forms, such as trailing, guarantee, and standard.

A trailing stop is the best way to avoid a beartrap. It tracks the market price by a certain amount of points and will close your position automatically if it rises.

You can lock in the maximum profit while reducing losses as early as possible into a beartrap.

Learn how to manage risk .

Bear traps and trading: Risks

Traders who believe that the price decline will continue decide to short (sell) an asset. The downward trend is temporary and the price begins to rise again. Short positions will be covered by traders, who are forced to do so as the asset’s price can continue to rise – and sometimes very quickly – causing significant losses for those caught in the trap.

Monitor the open short interest to determine how crowded a short position is. 2,3 The greater the short position in percentage of the free float, or the average daily volume, then the higher the risk of a potential bear trap, since more traders will be forced to cover short positions.

How to trade a bear trap

1. Create a new account , or Log in
2. Find out more about bear traps
3. Search for the bear trap in your CFD account
4. Select ‘buy to go long’ or’sell to go short’
5. Manage your risk by determining the size of your position and taking steps to reduce it.
6. Monitor and open your position

You’ll be trading using Contracts for Difference (CFDs) with us. Instead of owning an asset, you take a position based on the price movement.

CFD trading uses leverage, which means that you can lose or gain money very quickly. You could even lose more than your initial deposit to open a position because potential profits and losses will be magnified up to the full amount of the trade. Past performance does not guarantee future results.

Your initial margin and currency exposure will differ depending on the asset you trade with CFDs. Stop loss orders are often used by traders to manage their risk when trading CFDs.

Are you new to trading or investing? To build confidence, practice on a Demo Account.

Possible opportunities during bear traps

You can then wait until the price reaches its maximum after the sudden upward move. You can then open a short trade. You can also open a position long – during the downtrend, or after the initial rise – over a key technical threshold to profit from a future upward trend.