Bull Trap – How to Escape the Setup

What is a Bull Trap?

A bull trap occurs when longs take on a position when a share is taking off, only to have the share reverse and shoot lower. [1] This counter move produces a trap and often leads to sharp sell-offs. If you haven’t struck a bull trap, you then definitely don ‘t know about pain. After trading for 19 years, getting caught in a trap is one of the worst feelings in the world.

Emotions Behind the Pattern

The comprehension bull traps are tough for new investors is the emotional aspect of the trade. Think about it for a second. For most new traders you will enter your position with some level of apprehension because you are unsure about taking the position in the before all else place. Then something miraculous starts to happen. The share you were just worried about begins to rally and not just rally but does so with cost and volume.

In the flash of an eye, all of the worries wash away from you and your confidence begins to build. Then just as quickly as you feel you are in control of the situation, you wake up to a morning gap down or if you are day trading, the share just plummets on high volume.

Freeze Phase

At this point, you have just entered what I like to call the freeze phase. This is where you know you should sell, but are unable to because you believe the share will come back.

I think you know what happens at this point.

What You Will Get in This Article

Well, throughout this article, I will provide one simple method to protect yourself from being caught in the trap – accepting the risks.

Bull Trap Setup

Bull traps are really easy to identify on the chart.

You before all else want to locate a cost range that is broken to the upside. As soon as the share breaks this resistance it rolls over and crashes back beneath the breakout point with volume.

Bull Trap Charting Example

Below is an example of a bull trap that takes place in the share Honeywell (HON) over a two day period. HON broke out on the close of 9/6, only to gap down and break the low of the preceding range on 9/7. This sharp countermove produces the perfect bull trap.

Bull Trap

Strategy number 1 – Don’t Panic

Riding High

You went to bed and your long position was safe and sound. You could be up anywhere from 10% to 30%. Remember, you have likely enjoyed a positive position in the share for some time.

Something Bad Happens

So, you go from double digits to a losing position in a matter of seconds.

The before all else thing you want to do is stay calm.

Immediately look to the left of the chart to identify key support areas. This will give you some indication of how far the share can go against you.

Accept the Risk

Now that you have your “worst-case” scenario, start to analyze your risk exposure. Are you at risk of losing a lot of your portfolio on the trade?

Have you tripped your stops on the trade?

If the answer to both of these questions is no, then you need to accept the risk and manage the trade. According to author Mark Douglas, in his book Trading in the Zone he states, “The top traders not merely take the danger, but they also have learned to just accept and adopt that probability. ” [2]

Let’s look at a real-world example from my own trading, where I did not accept the risk and therefore took an unnecessary loss.

Real-Life Example of You can Lose Money Panicking

I had my eye on Zynga (ZNGA) for quite a while and decided to go long. I took a long position at $3.28 and the share immediately started to rally. Fast forward one day later and ZNGA hit an intraday high of $3.62 which was a gain of slightly over 10%. If you are not in control of your emotions, a quick 10% gain can cause a bit of an ego trip.

Now skip to day two of the trade and you will see that the share not only gapped lower but went well beneath my entry point, all the way to a low of $2.85.

Emotions Get the Best of Me

From what I remember, I felt sick to my stomach on the morning of the gap down. It wasn’t only I had been in a losing position, however I also provide the decree in order to prevent shares directly before his or her own earnings.

I beat up myself the whole pre-market from 8 am to 9:30 am when ZNGA started.

Do you need to be aware of the final effect of beating up myself for one hour and a half? I was such a panic condition, I out of stock of this positioning in 9:31’m at $2.88 pennies to get an ~12 percent loss.

You thought that is awful. Well relax and obtain your pop corn, the narrative gets worst. Thus, not surprisingly ZNGA drifts lower on the upcoming couple weeks to create an eventual low of 2.72. This might have meant I might have already been a total of 17 percent percent had I remained in the positioning. Sounds awful, but being 17% really isn’t the conclusion of earth.

Take a peek at what happened .

So you could be saying to yourself, well this trade worked out, but what if Zynga had tanked and you lose way more money.

I Didn’t Look to the Left for Support Levels

This really is a neutral viewpoint nevertheless, straight back again to what we discussed earlier in this guide, had I return a month or two I could have discovered the previous swing low on ZNGA was 2.50. While this will be a bigger loss than me shutting my posture in $2.88, it merely demonstrates my point that I wasn’t keen to just accept the probability.

I had opened the positioning, set a stop-loss sequence, however I wasn’t truly comfortable with the fact the marketplace can at times go against you quite violently.

What Happens When You Don’t Panic

I wouldbe re-missed when I simply left you with a gloomy article of panicking cost me money. Thus, allow me to reveal the way I have developed in a brief time frame to learn once I am “jammed up” and how to handle the trade effortlessly.

Do Not Set Huge Stops

Let’s before all else place the record straight, I am not indicating you ought to possess huge ceases of 30 percent or 40 percent. What I am saying is that as soon as you’ve realized you’re in a snare (with no matter how good you do this may happen), as opposed to panicking think during the next step down at which a dip could start to undo the snare.

CHTP Trading Example

My following real Instance is of this biotechnology firm Chelsea Therapeutics (CHTP). I got the share at $3.20. This really was my before all else trade of this New Year, and that means you can just imagine the emotional importance. Not forgetting I had only hit yet another summit in my own trading accounts; you might say I had been riding on a small higher.

I have to have understood I had been searching for a rude awakening. Sure, enough the marketplace delivered a wonderful bit of humble pie directly now.

CHTP such as Zynga began moving in my own favor. By the near the very following day, the share ended the day at $3.57.

This symbolized a newspaper profit of 11.5 percent.

Caught in a Trap

I had been intending on final 1 / 2 of this career to a morning soda nevertheless, the marketplace had different plans. From the sitting in my desk doing my pre-market scanning of available places and visiting that a trade encounter through at $2.50.

I remember thinking, something has to be defame with my feed. Therefore, I sought outside to Google and entered “CHTP quote” and saw consequences of 2.50. I guessed there has to be something . Therefore I moved on to the state Nasdaq site. In my gloomy surprise, CHTP in-fact was trading at the $2.50s. That represented a loss in more than 20% and also a ~30 percent swing from the preceding days’ closing cost.

I sensed complete defeat as I looked onto the monitor. I couldn’t believe I was caught in yet another bear trap similar to Znyga, but also that my losses were far greater.

Stop Looking for a Quick Fix. Learn to Trade the Right Way

Phoenix Rises

But, then something started to happen. I said to myself, “You have a losing trade also it’s quite awful. In case you close the trade out here you’ll obtain the immediate assistance of leaving the positioning, however, remember what happened with Zynga”. So instead of panicking, I looked at the chart to see the next support level down.

As I scanned back through the chart I noticed a swing low at $2.02 and another one at a $1.68. For me, this would have represented a potential loss of ~37% and 48% respectively. I sat at my desk and demand myself the very real question, “Are you really willing to drop the sum of funds and much more? “.

There were a number of thoughts that went through my mind as I pondered through the various outcomes. How did I let it obtain to this point? Why would I allow a stop so large on one position?

At the end of it all, I accepted the fact that the “marketplace happened” and there is nothing I can do about it. All I can do at this point is to manage the risk. So, with that in mind, I placed a mental stop loss at $1.68 and I was going to let the marketplace move in its desired direction.

When I looked at the chart, it appeared to be a massive shakeout, as CHTP had one of the highest down daily volume spikes in the share ‘s history. But hold on, things obtain worse.

Reading the News

I never read the news, but sometimes desperation will push a trader to his limits. I read that the share had gapped down due to some concerns around a pending FDA approval which would be announced on Tuesday and that the share would halt trading on Tuesday for the news.

Let me tell you that from Friday until the close on Monday was one of the hardest periods for me in my trading career. Even though I just committed myself to the possibility of a loss down to $1.68, I couldn’t prevent myself by thinking, well imagine should the share would go to 90 pennies or not! After all we have been speaking about a bio tech share and also we realize these are left and made countless for a great deal of individuals.

Accepting the Risks

After it was all done and said, I chosen to take the threat. Fantastic thing for me personally since the share gapped up and I managed to generate an instant 50 percent in under weekly. Now, I understand that isn’t ideal, and I rarely find myself in this sort of situation. The purpose is that if I did find myself at a jam, then I didn’t dread. I felt in my own was prepared for anything the marketplace had to attract my manner.

More Than Penny Stocks

In these examples, I have highlighted my trades in penny shares. While these charts will look crazy to traders of the S&P 100, the principles remain the similarly.

You need to make sure you manage your risks, honor your stops and protect your portfolio.

In Summary

There are probably a dozen or more methods for trading bull traps, but in the spirit of keeping things simple, I have focused on the one thing that matters the most – DON’T PANIC.

Panic trading happens much frequently than a lot of individuals would really like to admit. The comprehension is traders are in focused places or simply just need come to grips with the style they are able to shed the amount of money. This contributes to those bull shelters, where the feeble panic throughout climatic events and then unload their stocks into the wise money.

So, remember whether the marketplace goes against you at an abusive method, your discontinue thresholds are surpassed and also you are feeling whole despair. Don’t forget to just take a deep breath, relax and take care of the trade.

External References

  1. Bull Trap. Wikipedia
  2. Douglas, Mark. (2000). ‘Trading in the Zone: Master the Market with Confidence, Discipline, and a Winning Attitude’. Penguin Group. P. 2 1

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