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V.10:8 (351-353): Avoiding Bull And Bear Traps by Nauzer J. Balsara, Ph.D.
V.10:8 (351-353): Avoiding Bull And Bear Traps by Nauzer J. Balsara, Ph.D.
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Avoiding Bull And Bear Traps
by Nauzer J. Balsara, Ph.D.
Bull and bear traps are gap openings that are reversed the same day and that can cost a trader dearly. S&C contributor Nauzer Balsara presents his method of analyzing market history to calculate the proper placement of stops to avoid being caught in such traps.
A bull or bear trap occurs when a market does an about- face after an extremely bullish or bearish opening, leaving a trader who entered a position at the opening price with a possible loss at the end of the day. Bullish expectations are reinforced by a sharply higher or "gap-up" opening, just as bearish expectations are reinforced by a sharply lower or "gap-down" opening. A bull trap occurs as a result of prices retreating from a sharply higher or gap-up opening; the pullback occurs during the same trading session that witnessed the strong opening, belying hints of a major rally. A bear trap occurs as a result of prices recovering from a sharply lower or gap-down opening; the retracement occurs during the same trading session that witnessed the depressed opening, confounding expectations of an outright collapse.
BULL AND BEAR TRAP EXAMPLES
An illustration of a bull trap is provided by price action on December 3,1991, in July 1992 Chicago wheat futures (Figure 1). On December 2,1991, July wheat settled at 324.75 cents a bushel. A trader, noticing a strong uptrend in the July wheat chart, might not hesitate buying wheat futures at the gap-up opening price of 340.00 cents on December 3. However, instead of prices moving higher, they worked their way down to a low of 328.50 cents, bridging much of the 15-cent gap on the opening before settling at 330.50 cents.
Bull and bear traps are gap openings that are reversed the same day and that can cost a trader dearly. S&C contributor Nauzer Balsara presents his method of analyzing market history to calculate the proper placement of stops to avoid being caught in such traps.
A bull or bear trap occurs when a market does an about- face after an extremely bullish or bearish opening, leaving a trader who entered a position at the opening price with a possible loss at the end of the day. Bullish expectations are reinforced by a sharply higher or "gap-up" opening, just as bearish expectations are reinforced by a sharply lower or "gap-down" opening. A bull trap occurs as a result of prices retreating from a sharply higher or gap-up opening; the pullback occurs during the same trading session that witnessed the strong opening, belying hints of a major rally. A bear trap occurs as a result of prices recovering from a sharply lower or gap-down opening; the retracement occurs during the same trading session that witnessed the depressed opening, confounding expectations of an outright collapse.
BULL AND BEAR TRAP EXAMPLES
An illustration of a bull trap is provided by price action on December 3,1991, in July 1992 Chicago wheat futures (Figure 1). On December 2,1991, July wheat settled at 324.75 cents a bushel. A trader, noticing a strong uptrend in the July wheat chart, might not hesitate buying wheat futures at the gap-up opening price of 340.00 cents on December 3. However, instead of prices moving higher, they worked their way down to a low of 328.50 cents, bridging much of the 15-cent gap on the opening before settling at 330.50 cents.
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