Bull Traps are the enemy of Breakout Traders, and it’s important to learn the educational reference lessons when these scenarios trigger.
Goal #1 is to protect yourself from escalating losses on a breakout opportunity that failed and Goal #2 (for aggressive traders only) is to profit from a trade outcome failure by playing into the “larger than expected move in the opposite direction.”
Let’s take a look at the recent breakout and failure – trap – in Crude Oil and step inside the price action to build a foundation for understanding what’s going on and how to protect ourselves.
Here’s the Daily Chart of Crude Oil and the resulting “Bull Trap” that triggered this morning:
Without going into too much detail, let’s just reference the $103.50 area as an upper resistance key inflection level where a break above this level triggered a breakout opportunity into “Open Air” and a movement down against this level – especially with the divergences – triggered an aggressive “divergence into resistance” short-sell/bearish opportunity.
Monday’s Ukraine news thrust Crude Oil (and Gold) into potential breakout trade trigger mode as Money Flow took a Risk-Off posture.
Tuesday’s “Everything’s OK – Don’t Worry” news reversed these developments and Money Flow quickly shifted back to “Risk-On” Mode which thrust the S&P 500 to all-time highs.
Gold and Crude Oil suffered a reversal after initial breakouts, and buyers rushed to cover losing positions as short-sellers took the break under the $103.50 and $103 level as new trade entry triggers.
Here’s a peek inside the intraday chart with the Fibonacci Grid as a reference level:
Again, a technical (chart) breakout triggered above $103.50 but failed just as quickly when price gapped and traded down under this inflection or pivot level.
The result – at least so far – has been a collapse straight down away from $103.50’s key level down toward the initial target which was just achieved (the prior price and 50% Fibonacci Level into $101.00).
Note the Momentum Divergences that preceded both the January low (reversal up) and the expected March reversal down that was thwarted by a day of Bull Trap activity.
Let’s step the perspective in one more time to a Pure Price and “Value Area” Profile Chart:
Fibonacci and indicators aside, we see a Clear Value Area with upper resistance into $103.50 and lower support near $101.50. The Midpoint thus exists into the $102.50 level.
A break above the resistance high “Advertises Opportunity” (to use a Market Profile term) for buyers to step in and drive price away from Value.
On an initial break, buyers were unable to continue to push price higher and sellers became dominant on the “Everything is Ok/Don’t Worry” news.
From a price standpoint, sellers returned price to the upper resistance line ($103.50) and then pushed under it to trigger the resulting downside ‘collapse’ or return back to Value ($102.50) then the lower support target.
While we can’t predict which breakouts will succeed or fail, we can “predict” (at least from a high probability standpoint) that if price does trigger a Trap scenario like this, then we can expect price to return back to “Value” or a lower price target.
In other words, if you take a breakout trade opportunity like this, be ready to honor your stop if price does trade back under the breakout level.
Failure to trigger a stop-loss on a return under the breakout price exposes you to losses that mount quickly as price moves quickly down away from resistance.
If you didn’t take the breakout, or if you took the stop-loss without hesitation, aggressive traders have an opportunity to play the downward reaction that has trapped (in this case) buyers as they rush to liquidate losing positions at lower prices.
Use prior examples to continue to develop your knowledge on this important concept:
“Lessons from the August SP500 Bull Trap”
“Quick Lessons from Three Bull Trap Outcomes”
Always remember that it’s not your fault, and that the market isn’t “out to get you” if you get caught in a Bull or Bear Trap scenario.
Follow along with members of the Daily Commentary and Idealized Trades summaries for real-time updates and additional trade planning.
Corey Rosenbloom, CMT
Afraid to Trade.com
Follow Corey on Twitter: http://twitter.com/afraidtotrade
Corey’s new book The Complete Trading Course (Wiley Finance) is now available along with the newly released Profiting from the Life Cycle of a Stock Trend presentation (also from Wiley).