Today, you’ll learn what to do in a Bull Trap?
- Check if your entry is above a significant Support
- Look at the value of the RSI
- Find out if the MACD histogram is not decreasing if below zero or increase if above
- Check if your entry is in an uptrend
- Worse: Exit the trade immediately
In a bull trap, you can use four indicators to assess if there is a chance to hold the trade. The indicators are usually Support and Resistance, RSI, MACD, and trendlines. You can also exit the trade when there is a high probability of failure.
Sometimes when failure is obvious, the logical thing to do is close the position to reduce or avoid more losses.
It is the best thing traders can make because the market is usually unpredictable.
Due to its unpredictability, traders should follow their trading plan.
The exit plan should be followed, which is vital to be profitable in any market.
For example, setting maximum loss is a good method to utilize a good risk-reward ratio.
Risk-reward is important when trading a bull trap to avoid closing out a trading position earlier than planned.
Going back to the indicators above, a good strategy to use can be having two to three indicators to make a high probability decision.
As an example, traders can use MACD and RSI together to assist each other.
What is a bull trap?
According to Investopedia, a bull flag is a false signal. Meaning, the security appears to be bullish, yet it is going down. (source)
Traders are often panic when a false signal occurs. The ones who panic the most are the new traders.
New traders often buy securities without checking the overall trend because an indicator tells them to buy.
1. Check if your entry is above a significant Support
For bullish trades, it is vital to watch for strong or medium supports to plan trades carefully.
The plan should include the entry and exit points.
The exit point is usually important to include where to close a trading position after a break of significant support levels.
If support levels are not yet broken, then it is not yet time to exit the trade. With this information, traders can still hold their positions for a possible bounce to the upside.
Most traders panic when a bull trap happens without considering support levels.
2. Look at the value of the RSI
If you are in a bull trap, you can look at the RSI whether it is still above 50 levels.
Usually, above 50 is a signal that the trend is still bullish because the strength is strong.
If there is strength, then it is not yet time to sell the trading position. However, it does not mean that traders should never close the trade.
For example, when the maximum loss is near or reached, close the position immediately.
The maximum loss is also the number of money traders are willing to lose.
It is also an amount in which does not affect their trading account and emotion.
For example, a $100 loss from a $10,000 account is a measly 1%, not a big deal.
But for a $1,000 account, it is usually significant to the traders.
In the RSI indicator, look for a bounce from support to effectively reduce the losses on an RSI 50 level breakdown.
Usually, the breakdown is fast but will usually bounce at the RSI support level.
The bounce is a chance that traders often take to get out of a bad trade. In this case, a bull trap.
Discussing the RSI again, if it drops below 50, will you immediately sell your long positions?
Of course not.
The most logical way is to look for support within the RSI indicator.
We are talking about RSI support here which is different from what is in the price chart.
3. Find out if the MACD histogram is not decreasing if below zero or increase if above
MACD is an indicator that can be useful when a trader is in a bull trap.
In a bull trap, traders can look at the histograms for change in momentum or, traditionally, the MACD bearish crossover.
However, MACD bearish crossover is usually not reliable because the signal is often delayed.
So, it is better to look at the histograms instead.
The histogram can be below zero or above zero.
If below zero, the long entries are usually aggressive because the entries are often below MACD 0 line.
Less aggressive entries are usually a good entry because it is above MACD zero line.
It means that histograms are above zero levels which is a good sign when a trader suspects a bull trap.
Usually, if the histograms are growing, there is still an uptrend strength.
Otherwise, when the histograms are getting smaller above the zero lines, it is a sign to get out of the trade.
A good way to detect a bull trap is by combining both RSI and MACD.
This combination is usually a good trading strategy. However, it usually needs a backtest to find out the reliability.
To test reliability, traders can use amibroker, a good tool for testing trading strategies and implementing them in real-time or end of the day.
4. Check if your entry is in an uptrend
One of the mistakes most traders make is buying in a downtrend.
Buying in a downtrend is usually not a good idea because often, bullish signals are a bull trap.
The bullish signal can be a reversal signal from within a downtrend which is dangerous for traders.
The dangers of catching a falling knife are so high which may take out the trading accounts of several traders.
To avoid these dangers, it is often good to avoid buying in a downtrend that professional traders recommend.
Always check the trend of security to avoid a bull trap. When in a bull trap, check if your long entry is within an uptrend.
Otherwise, exit the trade immediately.
5. Worse: Exit the trade immediately
A bull trap can be damaging to your account if you are not careful.
Prudence can save a trading account. It is one of the reasons some traders set a time stop.
The time when to close the trade is already pre-determined.
For example, traders may set a three-day stop-loss, although all the indicators are showing bullish signs. Even if RSI is still above 50, exit the trade regardless of the signals from the indicators.
Often, a good trade usually shows signs within a few days. Otherwise, holding a losing trade for more than three days may indicate something is wrong with the entry.
Did you learn something about our post, “What to do in a bull trap?”