Bear Trap

What is Bear Trap?

Definition

A bear trap is a financial term used to describe a situation wherein, investors who sold short at the bottom of a down cycle get “trapped” at an unexpected reversal of the market. The opposite of this is a ‘bull trap’ which has to do with a false reversal of a declining price.

Understanding Bear Trap

A bear can be said to be a financial market investor who is certain about the decline in the price of a security, and suspects that the overall market may be heading towards a decline. A bear trap is an unfortunate situation that the “bear investor” gets into by selling shorts during a panic. This happens as a result of a market decline that causes investors to start short sales which loses value at a reversal.

Once longs start to enter the market, shorts investors begin buying out of losing positions which in turn escalates the upward price momentum and causes panic buying among other short-sellers still in the market. When the market panic is over and the short covering complete, the price slowly begins to reverse back into its downward trend. A bearish investor shorts their assets with an intention to buy them back after the price has dropped. Bear traps are not limited to a particular market as they can occur in all markets such as equities, bonds, currencies, and futures.