DEFINITION of 'Bull Trap'

A bull trap is a false signal indicating that a declining trend in a stock or index has reversed and is heading upwards when, in fact, the security will continue to decline. The move "traps" traders or investors that acted on the buy signal and generates losses on resulting long positions. A bull trap may also be referred to as a whipsaw pattern.

BREAKING DOWN 'Bull Trap'

A bull trap occurs when a trader or investor buys a stock that is about to breakout above a resistance level - a common technical analysis-based strategy. While most breakouts are proceeded by strong moves higher, there are some cases when the stock quickly reverses direction. These are known as "bull traps" since the traders and investors that bought in are "trapped" in the trade.

Traders and investors can avoid bull traps by looking for confirmations following a breakout. For example, a trader may look for higher than average volume and bullish candlesticks following a breakout to confirm that the price is likely to move higher. A breakout that's proceeded by low volume and indecisive candlesticks - such as a doji star - could be a sign of a bull trap.

From a psychological standpoint, bull traps occur when bulls fail to support a rally past a breakout level, which could be due to a lack of momentum or profit-taking. Bears may jump on the opportunity to short-sell the stock to send prices back below resistance levels, which can then trigger stop-loss orders from the originally bullish traders.

The best way to handle bull traps is to try and see the warning signs ahead of time, such as low volume breakouts, and then exit the trade as quickly as possible if a bull trap is suspected. Stop-loss orders can be helpful in these circumstances - especially if the market is moving quickly - to avoid letting emotion drive decision making.

Bull Trap Example

In the example above, the stock reaches a new 52-week low before rebounding sharply on high volume toward trendline resistance. Some traders may have jumped onto the move anticipating a breakout from the trendline resistance, but the stock quickly moved lower from these levels. The bulls may have become "trapped" in the trade and experienced losses as a result.

The trader could have avoided a bull trap by waiting for a breakout before purchasing the stock or mitigated losses by setting a tight stop-loss order just below the breakout point.

Chart courtesy of TradingView.

RELATED TERMS
  1. Bear Trap

    A false signal that the rising trend of a stock or index has ...
  2. Bull

    A bull is an investor who invests in a security expecting that ...
  3. Liquidity Trap

    The liquidity trap is a situation in which prevailing interest ...
  4. Bull Market

    A bull market is a financial market in which prices are rising ...
  5. Value Trap

    A value trap is a stock that appears to be cheap because it has ...
  6. Breakout Trader

    A breakout trader is a type of trader who uses technical analysis ...
Related Articles
  1. Investing

    Avoid These 3 Value Trap Stocks

    Investors are wise to do their homework and avoid the following companies that might be value traps.
  2. Trading

    Capitalize On False Breakouts In The Danger Zone

    Sometimes you have to be a predator to profit. Find out how to cash in on false breakouts.
  3. Trading

    Pros and Cons of These Breakout Stocks (FB, IM)

    These stocks are breaking out, or close to it. Here are the pros and cons of trading these stocks right now.
  4. Trading

    Long-term Upside Breakouts Close at Hand

    These three stocks are approaching major highs and resistance, and a breakout could mean another strong advance to the upside.
  5. Trading

    Watch for Breakouts in These Stocks (AVGO, ENB)

    These stocks could soon break out of ranging patterns. Here are two ways to trade the moves.
  6. Trading

    JPMorgan Chase Levels to Watch After Earnings

    JPMorgan has rallied into a test of the 2015 bull market high ahead of earnings, but a breakout may have to wait until a rate hike gets closer to reality.
  7. Trading

    Watch for These Stocks to Breakout Soon (ACM, ADBE)

    Four stocks close to breaking out of chart patterns, with anticipated entry points and profit targets.
  8. Trading

    Watch for a Breakout in These Stocks

    Following significant price moves, these stocks are currently moving in small price ranges and are poised for another breakout.
  9. Trading

    3 Rising ETFs Near Breakout Levels

    These ETFs, each focused on a different international market, are all rising and near breakout levels once again.
  10. Investing

    5 Methods To Avoid Value Traps

    Learn about five key factors that can help investors identify and avoid value traps in their stock market portfolio selections.
RELATED FAQS
  1. Where Did the Bull and Bear Market Get Their Names?

    The terms bull and bear are used to describe general actions and attitudes, or sentiment, either of an individual or the ... Read Answer >>
  2. How do I identify a stock that is under consolidation?

    Discover the three major characteristics stocks or securities exhibit when they are trading under a period of price consolidation. Read Answer >>
  3. How do I place a stop-loss order?

    Learn how to place a stop-loss order and how traders use stop orders to either limit potential losses or to protect part ... Read Answer >>
  4. How does a bull market in stocks affect the bond market?

    Take a deeper look at the relationship between the bond market and equities, and see what might happen to bonds during the ... Read Answer >>
  5. How do I use On-Balance Volume (OBV) to create a forex trading strategy?

    Read about some of the basic ways On-Balance Volume indicators can be used by forex traders to measure volume trends and ... Read Answer >>
Hot Definitions
  1. Business Cycle

    The business cycle describes the rise and fall in production output of goods and services in an economy. Business cycles ...
  2. Futures Contract

    An agreement to buy or sell the underlying commodity or asset at a specific price at a future date.
  3. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  4. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  5. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  6. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
Trading Center