Two Recent Insidious Bull Traps Revealed

Nov 12, 2008: 11:15 AM CST

The past few days have presented two complicated situations known as “Bull Traps” which have potentially resulted in large losses for those who took these trading signals.  Let’s review these two situations and see if there were any clues to avoid them… or if they were just ‘part of the game.’

DIA 15-min Chart:

Keep in mind that price is in an overall, strong daily (and weekly) downtrend, so that is the ‘backdrop’ or structure (headwinds) with which we trade at the moment.  It’s quite common to ask “when will the downtrend end?” or perhaps “is this selling swing too overextended and ready for an upside retracement?”.

On November 7th, there was plenty of reasons to believe a fresh upswing had begun, as the action on November 6th created quite a strong multi-swing positive momentum divergence (on multiple intraday time frames) and Friday’s (Nov 6) action was indeed an up-day that closed at the highs that featured a strong positive close.

The weekend passed by and price gapped strongly to the upside, signaling more strength from the buyers… but that strength never materialized.  Personally, I spent the day trying to trade long, finding many support areas taken out which resulted in small losses.  However, the day ended as a perverse trend day (I say perverse because most trend days open with a large gap and then continue IN the direction of the gap until the close) which left many traders perhaps confused.

Ultimately, the day was classified a “Bull Trap,” meaning price sent initial siganls one way… yet continuously dashed these bullish hopes all the way to the close.

Not to be outdone, the market created a very similar structural set-up on Tuesday, forming a large downside gap, continuing half the day as a “Trend Day” but reversing sharply after creating multiple positive divergences on intraday time-frames, breaking key resistance, and surging sharply higher, perhaps triggering many fresh but exhausted buy orders in the process… only to give back all those gains and more into the first part of today’s (Wednesday’s) trading.

The morning’s overnight gap was large and only a minimal ‘fade’ was attempted, and price is (currently) sharply on the lows of the day as Treasury Secretary Henry Paulson speaks to reporters.

The large upswing will also be classified as a “Bull Trap” which also caused many short-sell trades to be stopped out – perhaps it was a relatively large short-squeeze… perhaps both moves were.  The thing is that you have to take your predetermined stops and not look back – trade with a predetermined edge with concrete parameters (such as exiting when price breaks a key moving average or prior swing high/low) and not look back should the action be later deemed to be a “trap.”  Fortunately or not, no one has absolute foreknowledge of market moves.  We must control our risk and do the best we can within our own limitations.

So here we are now on a new price and momentum low on the 15-minute DIA chart and are left concluding “This is a very difficult market for everyone, both long and short.”

As that is the reality, it serves as a testament that capital preservation – and I don’t mean staying 100% in cash necessarily – is the #1 goal.  This might mean avoiding leverage, switching from futures to ETFs (be it DIA, SPY, or QQQQ), reducing normal trade position size, focusing only on known, high-probability set-ups, or tightening stops (which I don’t necessarily recommend in a highly volatile market).

Either way, let’s not get overly aggressive either long or short until some of the dust in the market settles.

4 Comments

4 Responses to “Two Recent Insidious Bull Traps Revealed”

  1. Anonymous Says:

    Man did I ever get caught in one of those traps. Thinking a short-term bottom was in, I called my broker the Monday morning of the 900+ point rip and asked him to put some money into my daughter’s 529 account. It didn’t hit til the end of the day, so I basically top ticked that one.

    Luckily, she’s only 4, so hopefully, we’ll recover by the time she needs that money. If not, maybe she won’t need that education afterall, as we’ll probably all be servants.

    -DT

  2. Anonymous Says:

    Sysin3

    sysin3@gmail.com

    I’m sure I could find it, but I’m a lazy old man…..

    What is your “momentum” indicator (there are so many, lol)

  3. Corey Rosenbloom Says:

    Sysin,

    No problem! It’s otherwise called the “3/10 Oscillator” but it can’t be reproduced exactly with StockCharts, so I have to use the MACD indicator and put in variables 3, 10, 16 in the boxes, making it the difference in a 3 and 10 period EMA which is smoothed 16 periods. The actual “3/10” uses a slightly different calculation and uses simple moving averages instead of exponential, but the effect is very close.

  4. Anonymous Says:

    Thanks

    I thought it looked a bit “MACD”ish, but wasn’t sure.

    OT, this here comment box does not seem to work right in Firefox ….. don’t you hate computers ? lol