How To Avoid A Bitcoin Bear Trap

How To Avoid A Bitcoin Bear Trap
Jonathan Hobbs

about 1 year ago4 mins

  • Bitcoin has its fair share of bear traps. It's what happens when the price looks like it’ll go down more, enticing bearish sellers and shorters to bet big – only to then rip higher instead, causing those players to lose big.

  • Bollinger bands can be useful in helping you spot potential bear traps. You’ll want to see daily candle closures back inside the bottom band as an early warning sign that a trap’s in the making.

  • Bitcoin has bull traps too, which punish late buyers who buy after a big spike higher. Buying the dips (and not the rips), can help you avoid them.

Bitcoin has its fair share of bear traps. It's what happens when the price looks like it’ll go down more, enticing bearish sellers and shorters to bet big – only to then rip higher instead, causing those players to lose big.

Bollinger bands can be useful in helping you spot potential bear traps. You’ll want to see daily candle closures back inside the bottom band as an early warning sign that a trap’s in the making.

Bitcoin has bull traps too, which punish late buyers who buy after a big spike higher. Buying the dips (and not the rips), can help you avoid them.

Bitcoin dropped about 12% in the first half of February – only to then blast 18% higher to a new yearly peak of just over $25,000. It was a classic “bear trap” for investors who sold after the drop, or traders who tried to short the OG crypto, expecting to profit from an even bigger downside move. I think the road to higher bitcoin prices will be littered with traps just like this, so here’s how to spot them – and even use them to your own advantage.

What’s a bear trap?

Simply put, it’s when the price looks like it could go much lower, but instead rips higher. And as a result, it traps the bears who shorted or sold the investment at the worst possible time.

The trap typically plays out in three phases. First, there’s the build-up phase, where the investment is trending upward and everyone who owns it is making good money. Then there’s the trap-laying phase, where the uptrend slows down and then drops hard and fast. This phase often comes with some kind of bad news catalyst, which draws all bears out from the woods. Finally, there’s the trap phase – and that’s when the price quickly jumps higher. This forces short-sellers to exit their trades for big losses, and entices investors who sold their holdings (in the trap-laying phase) to buy back in at higher prices.

This all just played out to a tee with bitcoin. After a monster rally in January (build-up phase, orange), the price began to stall. Then came the bad news on February 9th (gray): the US Securities and Exchange Commission (SEC) had charged crypto exchange Kraken for not registering its staking products as securities. Whether or not staking products are securities is still a big debate among regulators, and one we’ll likely hear more about this year. Still, the news was enough to drive bitcoin’s price lower in the short-term, laying the bear trap (blue). Bitcoin then staged a rally (white), after a fairly unsurprising US inflation report on Tuesday.

Chart drawn with TradingView.
Chart drawn with TradingView.

So how do you spot a potential bear trap in the making?

It’s not so easy, as bear traps are, by their very nature, meant to trick investors. But I’ve seen my fair share of bitcoin traps over the years, and found a simple Bollinger band strategy can be pretty good at alerting you when there might be one underfoot. You can read a full guide on Bollinger bands here, but for the sake of bear traps, you’ll just need to understand that Bollinger bands get wider when an investment gets more volatile, and narrower when it gets less volatile.

So on February 9th (gray), when bitcoin dropped about 5% on the Kraken news, you can see below how the bands got wider as volatility started to tick up. The price then finished the day below the bottom band – with the red body of the candle closing half outside it. On February 10th, the bands got even wider, again with a daily candle closing below the bottom band. But on February 11th, things switched around: bitcoin had a green day, with its daily candle closing back above the bottom band. If you were using the strategy, it would have set off your trap detector. The technical sign indicated that the buyers weren't about to give up so easily, and that sellers were starting to lose momentum. In other words, you’d have been alerted to the possibility that the price could be setting up to move higher instead of lower.

Chart drawn with TradingView.
Chart drawn with TradingView.

This kind of trap alert would’ve worked plenty of times with bitcoin in the past (or other investments, for that matter). Here’s an example of a major bear trap in September of 2021:

Chart drawn with TradingView.
Chart drawn with TradingView.

And two more in 2017…

Chart drawn with TradingView.
Chart drawn with TradingView.

What’s the big lesson here?

Holding an investment for the long-haul is no easy feat, especially one as volatile as good ol’ bitcoin. But if this is indeed the start of a bigger uptrend, you’ll want to stay in your trade for as long that trend remains intact, and not get shaken out too early by bear traps. For your best chances of doing that, I’d recommend getting up to speed with Bollinger bands, and learning how to add them to your own bitcoin chart in TradingView. That’s all laid out for you here.

Bitcoin can be frustrating for investors. You want to buy and hold it when it trends higher, but when it does, it usually comes with big dips along the way that make you second-guess your decision. But if you’re a true-blue, long-term bitcoin believer, you just might see these traps as an opportunity to top up your position. It can also be less risky than buying just after the price has spiked higher in the short-term – a scenario more prone to bull traps. Those are good for snaring late buyers (instead of sellers), and you’ll want to steer clear of them too.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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