Bear Trap Definition: Day Trading Terminology
A bear trap is a colloquial trading term used to describe common situations in the market that seem to indicate a coming downturn in a security, but actually lead to a steady or increasing price. As traders who are generally looking to short sell downward price trends, bearish investors are vulnerable to these deceptive market events.
Bear traps come in all shapes and sizes, but they share the common subjective characteristic of being deceptively attractive to traders with a bearish sentiment.
Bulls and Bears
The terms bulls and bears are used to describe traders with positive and negative market sentiments respectively. While these are not set attitudes, and a trader can be bullish toward one security while being bearish toward another, traders do tend to generally lean toward one sentiment or the other.
Traders are either seeking out promising securities with unrecognized potential or they are looking for overvalued securities that have some hidden flaw that the market has not yet perceived. These two approaches tend to favor certain personality and trading types, and most traders will lean more toward one side of the spectrum than the other.
Bears, therefore, are eager to discover information or identify price patterns that could indicate a coming downturn in price so they can short sell that security.
Short Selling or Shorting, the Short Squeeze and Bear Traps
Short selling or shorting is the act of betting against a security and entering a trade that will profit as the price falls. There are a few different methods for shorting various types of securities, but the most common is to borrow the shares from a broker on margin and sell them at the current price, with the hope of being able to buy them back later at a lower price to return to the broker.
This method of betting against a security means that bears are more prone to losses from a rising price than bulls are to a falling one. As the price of the security rises, the short seller will need to buy shares to maintain their margin rate. If enough short sellers are forced to buy, then they push the price of the security even higher, which leads to further margin calls that amplify the effect of the initial price increase.
Therefore, bearish traders need to be particularly cautious about entering their short trades, as bear traps tend to snare enough bearish traders that the price increase will be substantial enough to inflict serious losses on the trade.
Due to the nature of short selling or shorting, bearish investors need to be extra cautious when entering a position, particularly a position that is likely to attract many other bearish investors. A bear trap is a common enough occurrence in the market to have earned its own nickname, and bearish day traders need to be aware of this feature of contemporary short selling.