Bull Traps, Bear Traps and Short Squeezes
Alex Dixon, YouCanTrade
Bull traps, bear traps and short squeezes happen in the markets often enough that they have been given names. These three things are similar in how they accelerate price movement and cause people to exit when they are on the wrong side of the market.
A bull trap is essentially a false signal on a technical level luring traders into taking a long position with expectations of momentum pushing the price higher. After the price rises, it then reverses as traders start selling off their shares. When the sellers enter the market, upward price momentum will slow and then reverse, driving price down further as sell orders increase. As the long position traders start to exit their positions as part of the avalanche of sell orders, the “bulls” end up trapped with losses.
On the other side, bear traps start with price moving lower, creating expectations of continued downtrend price movement. When the trap kicks in, buyers drive price up and sellers may get caught on the wrong side. When they exit their positions to cover their losses with buy orders, the price gets driven even higher. This creates the same result as the bull trap, but on the opposite side, as the “bears” are trapped with losses.
Short squeezes are like bear traps except they may not have anything to do with a technical indicator. When price is driven higher, short sellers are forced to cover their position through stops, margin calls or exiting the position. As these shorts are covered and the buy orders are placed, price is driven higher. It is also common with short squeezes for people to exercise their options fueling the rise in prices. This trap ‘squeezes’ the shorts out of the market.
Bull traps, bear traps and short squeezes can be hard to navigate if you get caught in one. The best tactic is to recognize the signs before they happen. For a deeper look into more stock trading strategies, join the live trading rooms as part of our All Access Pass. Learn more.