Bull trap definition
A bull trap is a classic definition of a false breakout. In general, the buyers enter a trade with a strong conviction of an upside, however the stock fails to deliver the upward move and in turn hits the stop loss or support levels. Such incidences not only affect the trading morale, but raises doubts on the trading strategies. Subsequent triggers in the stop loss induce “fear of uncertainty” and feelings of “staying away” enters the system.
What to do when you fall in a Bull Tap??
The first response should be to exit the trade, rather than getting emotionally attached to the feeling of making profit. If not exited, the loss may widen and even lead to a disastrous situation going ahead. (BANKNIFTY weekly chart)
The price will tell you that it is bull trap; one way to identify is the swings with volatile volumes seen after the breakout levels. If the breakout is not a trap, then the price will show a consistent rise with closing above the previous high, at least for 2-3 sessions after the breakout neckline.
How to not fall into a Bull trap?
Once the stock breakout, wait for the rally to sustain with decent volumes. Having volatility in volume structure reflects uncertainty and indecision. Better to hold nerves and let the price settle keeping behind all the swings it has witnessed.
Make use of 2-3 technical / price indicators for a substantial confirmation. One can rely on a single indicator, however having more than one indicator helps to gauge the right momentum. That’s said, having more than 3 indicators also create confusion. Thus the ideal strategy should be to rely on limited technical indicators.
Three indicators are
Moving Averages: The major moving averages are 50-days moving average (DMA), 100-DMA and 200-DMA. While identifying a trade, list down stocks that are trading above these averages. Trading in a stock below these averages increases the risk of identifying strength, direction and momentum.
Chart Patterns / Candlestick patterns: Charts pattern like Inverse head and Shoulder, Double bottom, Falling channel pattern, Symmetrical triangle, Ascending triangle assist in exhibiting a positive outlook. Candlestick patterns like Bullish engulfing, Morning Star, Piercing line, Three White soldiers and Hammer are bullish indicators.
Technical Indicators: The two widely used indicators are Relative Strength Index (RSI) and Moving Average Convergence Divergence (MACD). RSI determines the strength in oversold and overbought conditions; also crossovers determine the positive upside. Whereas, MACD facilitates the underneath buying momentum identifying the direction on the zero line and crossovers.
One needs to develop strategies that provide confirmation on the correlation of these indicators. A confirm trade is said to have all these indicators giving a buy signal. Lacking in one of the indicators may increase the quantum of risk in a trade.
How to identify a bull trap before entering into a trade?
Trading is a difficult part of any investment activity. Before entering into a trade, one needs to gauge the overall outlook of the stock market. If the trend is certain and upward, the trade you enter may not need that extra cushion one has to take. Trading simple with a trend helps in building a strong “Trading confidence”.
Have the knowledge of the sector or index in which you want to select a stock. In some cases, the market trend might be volatile, but some specific sector/ index may exhibit the strong momentum. If the index looks positively trading, identifying a stock gets easier.
Avoid trading in stocks which are vulnerable to any corporate developments. Such situations exhibit uncertainty and potential volatility rise as the development