This article on trading bear traps is the opinion of Optimus Futures.
There are several strategies that traders can apply to make money trading futures.
One of the most common is momentum trading.
These strategies rely on following a trend with the expectation it continues.
You’ll also hear these called ‘trend following strategies. However, breakout trading also relies on momentum as well.
The difficulty with any of these is knowing what’s a real continuation of a trend and what’s not.
Quite often, what you think will happen never materializes.
That leaves you open to sharp reversals that can quickly put you on the wrong side of a trade.
Today we’re going to talk about one of those scenarios called the bear trap.
Bear Traps Defined
A bear trap can occur when traders believe the underlying futures prices are breaking down, showing serious weakness.
Bear traps often occur in longer-term uptrends, usually in a bull market phase.
Just when prices are going to collapse, they sharply reverse and trade higher.
What looked like a classic down break turns out to be a fakeout that draws more shorts in and “traps” them.
Also Read: Breakouts vs Fakeouts: How to Tell the Difference When Trading Futures
Also known as a short-squeeze, short-sellers get stuck in a trade where the asset keeps rising in value. This puts traders in a position where they hold short positions.
Eventually, they’re forced to close their positions by buying back the contract. That, in turn, sends prices higher, causing more shorts to exit their trades, leading to a cascade of buying.
Bear Traps In Action
We recently saw this in the commodities market, which has been exceptionally volatile.
On February 17, 2022, Crude Oil futures slid from $96 down to $88.
It looked like crude oil was topping out and finally headed for a pullback after a multi-month run.
Chart: Optimus Flow Platform
Except that’s not what happened.
When the price cracked the previous lows of $89, bearish traders thought they had a shot at riding crude lower.
However, bulls turned things back around as the broader trend took hold. Plus, the invasion of Ukraine created one epic run that sent oil over $100 for the first time in over a decade.
Recognizing A Bear Trap
While identifying the bear trap is always easy in hindsight, that isn’t always the case when trading. But, there are some things you can look at, which should help you gain some clues.
For example, you want to pay attention to trading volume to get an idea of where most of the buyers accumulated.
In the crude oil example above, it looked like $89 is where a lot of the accumulation occurred.
However, if you took a broader view of the market, you’d notice that a better support level was near $86. If price broke that level, that could have put a lot of long traders in losing positions.
Be skeptical of moves when volumes are low.
Next time you’re analyzing a chart, check out the volume bars to see where accumulation and distribution are. Ask yourself, at what price point do the longs start to feel some pain, and likewise for the shorts.
One great way to identify this is through volume profile charts. If you’d like to learn more click here.
Other Strategies For Spotting Bear Traps
Several futures traders rely on technical analysis to distinguish support and resistance areas. They search for key levels in which they believe buyers will step in and places where those buyers will be met with resistance.
Some traders will plot Fibonacci lines on their charts. Others may use volatility bands or indicators like the relative strength index.
If the futures cannot break one of the key levels, then there is a likely chance the buyers will step in and support the market.
However, as we pointed out earlier, you want to compare these potential support and resistance levels across multiple time frames to ensure you don’t get caught in a short-term trap.
Why Bear Traps Occur Even Though Traders Are Aware Of Them
Human emotions like fear and greed still play an instrumental role in trading. And while a large portion of trading today is programmed, with algorithms doing most of the volume, the markets can get irrational.
For example, all you have to do is look back at April 20, 2020, when crude oil futures closed NEGATIVE! The May 2020 WTI crude contract dropped 306%, or $55.90, to settle at (negative) $37.63 a barrel.
Traders who were trying to buy the dip that day got hurt badly.
There is an old saying on Wall Street and in CME Pits and that’s the markets can stay irrational longer than you can stay solvent.
Overly aggressive shorts can sometimes create a “short squeeze” if there is a bullish catalyst. And while we see this a lot more in the equity markets, remember GameStop and AMC, it is also possible to see it in the futures market.
Bear Traps vs Bull Traps
On the other side of bear traps, we find bull traps.
Bull traps are positions that break through previous resistance, sucking in breakout traders who expect the price of a futures asset to climb higher.
Similar to bear traps, we find bull traps in strong trends, in this case, downtrends.
In both cases, the markets move in a way that is designed to lure traders into an incorrect position before turning around on them.
Bottom Line
Momentum trading is not as easy as some people make it out to be. There are moments when the futures price is on the verge of collapse, but it suddenly reverses. While they may appear random, you can identify them as bear traps in some cases.
One of the keys to avoiding these traps is to take a step back and look at a longer time frame. Ask yourself whether the price is heading higher, lower, or sideways.
That will help get you in the right mindset to avoid traps.
Optimus Flow, our flagship platform, is great for organizing charts with multiple time frames on the same screen.
Its intuitive features let you easily navigate the platform, and our snap feature with windows gives you a crisp, clean setup.
Sign up for your Optimus Futures trading account today and get started trading with as little as a $100 deposit.
And whenever you need it, our boutique customer service is there to help you out.
There is a substantial risk of loss in futures trading. Past performance is not indicative of future results.
