What is a bearish trap and how not to fall into them

During the first 15 days of February, Bitcoin lost about 12% of its value to then take flight with a brand new 18% rise, marking this year's new high above $25.000. This move is a bearish trap popularly known as a “bear trap” for investors who sold after the drop, or for traders who tried to short in hopes of profiting from an even further downward move. Let's see how we can detect these traps and use them to our advantage.

What is a bear trap.

As the phrase indicates, a bearish trap is a moment in which we see that the price could go much lower, but instead it suddenly changes direction and shoots up. This causes traders who took a short position hoping that the bearish movement would continue to be liquidated en masse. These traps usually develop in three phases:

1. Accumulation phase: the asset in question is in an upward movement that benefits investors who jumped on the trend.
2. Placing the bearish trap: at this moment the bullish trend begins to show signs of exhaustion and then begins a bearish movement that is executed quickly and strongly. This event is usually accompanied by bad news that causes investors to begin short positions in anticipation of a greater downward movement.
3. Execution of the bearish trap: This is when suddenly, the price of the asset in question shoots in the opposite direction quickly. This causes liquidations by traders who positioned themselves short, causing them large losses. This in turn causes traders to rejoin the bullish movement trying to recover the losses caused by falling into the trap.

Recently we have been able to see the achievement of a bearish trap in Bitcoin. During the month of January we saw an astonishing revaluation of Bitcoin, preceded by signs of trend exhaustion at the beginning of February. The second phase of the trap then began with the news about the closure of Kraken staking and the 30 million fine imposed by the US Securities and Exchange Commission (SEC). This caused the 12% drop that we mentioned at the beginning, which we can consider the placement of the bearish trap. Next, the US inflation report released last Tuesday surprised investors with positive expectations, which helped Bitcoin overcome the loss caused by the SEC sanction.

How to detect a possible bearish trap.

Detecting bearish traps is not always easy, given that their nature is precisely to deceive investors. But there is a strategy that we can follow to try to detect them and take advantage of them. This strategy is based on Bollinger bands, which if you don't know how they work you can review it in this article we published previously on the blog. Let's see what this strategy is based on:

1. On February 9 when we saw Bitcoin drop about 5% on the negative news of Kraken staking being shut down by order of the SEC, we can see how the Bollinger bands widened as volatility increased. The price of Bitcoin ended the day below the lower band, closing with the body of the bearish candle outside it.
2. The following day, February 10, the bands widened much more and the same situation was repeated with a closure with the body outside the band. This would be the signal that tells us that the bearish trap has been set.
3. But on February 11, things changed: Bitcoin had a green day, with its daily candlestick closing above the lower band. This showed us that the bulls (buyers) were not willing to throw in the towel and that the bears (sellers) were beginning to lose strength. That is, we can interpret this movement as an alert of a possible rise in the asset instead of a continuation of the bearish movement.

This example that we have exposed is not the only one (nor the last) to emerge in the price of Bitcoin. Previously we could see a bearish trap during the month of September 2021 or previously on two occasions during 2017:

Conclusions on bearish traps

Maintaining a long-term investment is a challenge, especially in assets with high volatility such as cryptocurrencies. Whenever we buy and hold the investment in profits it is easy, but along the way we must face falls that make us doubt if we are doing the right thing. Therefore, these bearish traps can help us position ourselves again and continue accumulating bitcoin at lower prices. This can be much safer than buying after a bullish move in the short term, which is an ideal environment for bullish traps. These are the ones that tend to catch buyers who arrived late to the trend, which we will want to avoid at all costs.