What is a Point & Figure Bull Trap?
The Bull Trap Point and Figure sell signal appears frequently during a bear market. The pattern is simple in construction, yet powerful. An abrupt price reversal confirms completion of a dead-cat bounce, trapping longs on the wrong side of the market, preceded by a swift downside trend reassertion.
The bull trap pattern evolves from an upside breakout. The breakout could be any of the bullish chart patterns, for instance a Double Top, Triple Top, Quadruple Top, Bullish Triangle or Bullish Catapult. However, the breakout only travels one to two boxes, then fails, there is no upside follow-through. A 3 box reversal down prints. The price breaks south, sinking down through the foundations of the failed bullish pattern.
When to open a short position?
Shorts are best entered on the 3 box reversal down following the upside failure, providing the stock is locked in a bear market. Consequently, that point provides the optimum risk-to-reward ratio.
Bull Trap interaction with P&F chart levels
Bull Traps developing across horizontal resistance, or trendline resistance, carry additional downside clout. Resistance levels always see greater volume and in turn that exacerbates the sell signal. Effectively, more investors are trapped in losing positions, forced to sell.
Psychology of the Point & Figure Bull Trap
The Bull Trap pattern's build up cleverly lures investors into a false sense of security. The apparent upside breakout sucks new buyers into the market. Often, the upside pop coincides with a rosy news story or hopeful rumor. Either way, traders are confident a rally is commencing and they optimistically jump on board. However, the market has other ideas, reversing course sharply, sinking back down into the prior range. The newly long investors are instantly in losing positions and a wave of panic ensues. Pain is felt, selling pressure intensifies, the price accelerates to the downside.
Trading a Bull Trap
Upon Point & Figure Bull Trap confirmation we recommend investigating the chart, and market climate, deeper for concrete conviction.
- The Bull Trap sell signal only really ever produces a sustained downside move when the stock is contained in a bear market or prolonged correction. To make that deduction, look for trading beneath a significant overhead bearish trendline.
- Avoid trading a suspected P&F Bull Trap during a roaring bull market as the chances of failure are high. That said, the only time you would consider trading the pattern, without a bearish trend, is when development occurs across a long-term resistance ceiling.
- Successful, and clean, sell signals preceding the Bull Trap, add conviction. Previous instances of Bull Traps, over the prior months and years, collectively add downside confidence.
- As well as needing a bear market on the price chart, the relative P&F chart should also exhibit a bear trend. Ideally trending down on a medium to long-term basis. The only time a bullish relative chart could be considered as acceptable, is when the ratio has encountered a long-term horizontal resistance level.
Sentiment consideration is vital!
An optimistic jolly news story nearly always comes hand-in-hand with a Bull Trap. Investors buy on the news, the news is rapidly priced in, selling naturally follows, resuming the dominant trend. Therefore, sentiment must be scrutinized in tandem with the chart activity.
Trade entry timing
Once a Bull Trap Point and Figure pattern is confirmed, on the 3 box reversal down, and the above criteria satisfied, short positions are called for. Conservative traders could wait for secondary confirmation via a breakdown signal, such as a Double Bottom. However, with secondary confirmation the risk-to-reward is less favorable, since a good chunk of the downside break may have already occurred.
The Bull Trap has decent reliability in a bear market plus is it one of the strongest sell signals. However, in a trending bull market, Bull Traps are likely to be short lived healthy retreats, opportunities to buy, but not to go short.
Where to place a stop-loss?
A Bull Trap is a failed breakout of one or two boxes. Therefore, the stop-loss should be positioned three boxes above the breakout level. As the downtrend extends, and subsequent counter-trend X columns form, the stop-loss could be trailed lower to one box above those completed columns.
How to determine a downside price target?
Fast, and often volatile, trading follows this sell pattern. As a result, the price objective should be simple but logical. Identify significant levels of potential support lower down the chart and aim for a test. However, should the price make record lows, with no support levels to work with, use a vertical count.
Bull Trap Explained by Example
Bull Trap pattern into trendline resistance
The United States Oil Fund, an etf that tracks the price of Crude Oil. The chart produced a classic Bull Trap in September 2019, a dead-cat bounce straight into overhead Bearish Trendline resistance. Furthermore, the price pop was driven by a freak, transitory news-story. It rarely pays to trade on news-headlines, particularly against a downtrend that is dominant.
Sell signal behavior repeating
History does not repeat? Well, the Helmerich & Payne is an example that on P&F charts, repetitive trading sequences do occur. A Bull Trap pattern formed into a Bearish Trendline in December 2018, followed by a downtrend reassertion. Eight months later, July 2019, another Bull Trap sell signal prints, slamming into Bearish Trendline resistance, followed by a sharp downside price reassertion.
Bull Trap across resistance ceiling
Diamond Offshore Drilling confirmed a two box Bull Trap in July 2018. The price rolled over, reasserting the longer term downtrend. Just over a year later, October 2019, the price has collapsed all the way down to $5, a 70% decline!