Day trading can be a profitable endeavor, but it’s essential to avoid bear traps. A bear trap is when you think the market is going down, so you sell your stocks, and then the market reverses and goes up. This can lead to huge losses if you’re not careful. This post will discuss how to identify bear traps and avoid them!
What Is a Bear Trap?
Bear traps are a type of trading event in which traders attempt to profit from the decline of an asset that they believe will eventually reach zero value.
The majority happen during strongly trending markets when short-term price action suggests there’s about ready for another turnaround—which prompts lots more coverings up by both sides at exactly worst times! You can group these types under “bear” or simply wait until it breaks through before you start playing with your money again – because no one knows what might happen next.
Bear Trap Example
Tesla stock has gone from $1 to over 500 times that price in just five years. And the best way for investors like Jim Chanos and David Einhorn, who are short on Tesla shares, to get out before their positions get decimated even further is by selling off all of its assets at once when there’s an opportunity. As such, they have complained about accounting practices and financial viability concerns with how CEO Elon Musk runs his company– but most importantly, he seems to have gotten away with it. For now.
The problem with this strategy is that it can backfire if the market reverses and goes up again. This is what’s known as a bear trap. And it can lead to huge losses if you’re not careful.
How to Avoid a Bear Trap
It’s hard enough to be a successful investor, but traders are terrible at predicting what will happen next. They get into trades where they should have seen warning signs, and now their wallets hurt from all the money that went down together!
Practice Risk Management
Risk management is the first factor in protecting your trading account from any trade. If you plan and manage both position size, stop loss, and risk per trade, it’s hard for a bear trap or not to cripple you as a short seller, so be sure that have rationalized risks measured by the percentage of funds tied up into this strategy which according to investor and author, Van Tharp would look something like this:
Risk per trade = (Entry Price – Stop Price) / (Account Size * Percent Risk Per Trade)
– where the stop price is the price at which you will exit the trade if it goes against you, and the percent risk per trade is the percentage of your account you’re willing to risk on any trade.
For example, let’s say you have a $100,000 account and are willing to risk 0.50% per trade. That means your risk per trade would be:
Risk per trade = (Entry Price – Stop Price) / (Account Size * Percent Risk Per Trade)
= (100 – 99) / (100,000 * 0.005)
= $100 / $500
= 0.20%
So in this example, you would risk $200 on a trade where your stop loss was $99 per share.
This is just one way to manage risk. There are other methods as well. But the important thing is that you have a plan to manage your risk.
You’ll likely get caught in a bear trap if you don’t practice risk management. And that can lead to huge losses.
Pay Attention to Technical Patterns
One way to avoid bear traps is to pay attention to technical patterns. These reversal patterns can signal that the market is about to turn. Some common reversal patterns include:
- Head and shoulders
- Inverted head and shoulders
- Double top
- Double bottom
- Triple top
- Triple bottom
If you see one of these patterns forming, it could signify that the market is about to turn. And that means you should be careful about taking short positions.
Of course, technical patterns are just one tool. They’re not perfect. But they can give you a heads up that a bear trap might be forming.
Don’t Short Into Upside Momentum
Another way to avoid bear traps is to avoid shorting into upside momentum. This is when the market is moving up and shows no signs of slowing down.
If you short into this momentum, you’re likely to get burned. The market could keep going up, and your losses could pile up quickly.
It’s often better to wait for the momentum to die down before shorting. That way, you’re more likely to get a better price and less likely to get caught in a bear trap.
Wait for Confirmation
Finally, it’s essential to wait for confirmation before shorting. This means waiting for the market to turn before taking a short position.
If you don’t wait for confirmation, you could get caught in a bear trap. The market could keep going up, and you’d be left holding the bag.
It’s often better to wait for a clear signal that the market is turning before shorting. That way, you can avoid bear traps and protect your trading account.
Summary: Bear Traps
Bear traps are dangerous for day traders. But there are ways to avoid them. By practicing risk management, paying attention to technical patterns, and waiting for confirmation, you can stay safe and protect your trading account.
Furthermore, a few things to consider when trying to avoid bear traps. The first is to pay attention to the overall trend of the market. If the market has been trending down for a while, it’s more likely that a bear trap is forming. Also, be on the lookout for news events that could trigger a sell-off. If there’s a lot of negative news about a particular stock or the overall market, it could be time to sell. Finally, don’t get too attached to any one stock. If it looks like a bear trap is forming, don’t be afraid to sell and take your profits.
Following these tips can avoid bear traps and make money in the day trading market!
Learn More
Maurice Kenny has helped over 600 people become financially free through one-on-one coaching, mentorship, and options trading strategy. Many of these new traders are now full-time traders, and they all started by watching his 1-hr webinar.
Feel free to check out other FREE educational resources to help guide you as you begin your new journey to financial freedom.
Also, download a (FREE E-BOOK) by Maurice Kenny, “DAY TRADE LIKE A MILLIONAIRE.”
