Day trading is one of the most promising ways of making money online. It has little barriers to entry and can be done on a full-time or part-time basis. Also, the amount of money needed to start day trading is not much.
However, day trading is not a straightforward process, which explains why many people don’t succeed in it. Some causes of losses in trading are lack of proper analysis, bad luck, and psychological reasons.
In this article, we will look at some of the most popular traps that lead to losses in the market.
Contents
Two Type Of Day Trading Traps
You can divide these traps into two basic categories: bull traps and bear traps. The terms “bull” and “bear,” of course, are essential to day trading.
A bull market is one in which stock prices are generally rising or predicted to rise. A bear market, by contrast, is characterized by stocks with falling prices.
With those definitions in mind, let’s examine the two types of day trading traps.
Bull Traps
A bull trap involves the falling scenario: The price of a particular stock is trending downward but suddenly begins to rise. However, that upward tick is destined to be extremely short-lived because so many people immediately purchase that stock.
As a result, the stock’s buyers soon outnumber its sellers, a situation that causes its price to go into a tailspin.
Therefore, to find a stock price that’s truly on the upswing, look for a stock that begins the day among the bottom one-fifth of all stocks in terms of price and ends the day among the top one-fifth.
If a stock price manages to keep climbing throughout the day, the trend is most likely solid and reliable.
Related » Find the best ones entry points
Bear Traps
Now, a bear trap is basically the reverse of a bull trap. The price of a stock begins to drop, and many traders who bought that stock immediately start selling it — they want to unload it before they lose too much money.
Because of this mass selling, that stock’s pool of sellers far exceeds its pool of buyers, and the price begins to rise.
There’s one basic lesson about trading stocks that you can draw from this examination of marketplace traps, and that’s the importance of avoiding rushed purchases and sales. So, following the Crowd Strategy is good, but you need to be carefull.
Keep a cool head and always try to answer this question: Does a bump or a dip in the price of a stock represent a sustainable trend, or is it merely an abrupt and temporary incident?
Bonus: Psychological traps
Other kinds of traps in the market are psychological in nature. In most cases, these traps are known as biases. Some of the most popular traps in the market are loss aversion, recency bias, overconfidence, and paradox of choice.
- Loss aversion bias – This is a situation where a trader feels bad after making a loss compared to an equal profit. The best way to avoid this bias is to realize the three probabilities of all trades: break-even, loss, or profit. After doing this, you should set your stops well.
- Recency bias – This is a situation where a trader focuses more on what has just happened. Also, traders assume that future events will resemble recent events.
- Overconfidence bias – This is a cognitive situation that makes people believe that they are better than others.
- Paradox of choice – This is a concept that suggests that an abundance of choices is often not a good thing. In trading, you can see this in the form of the number of assets that are available in the market.
How to avoid bull and bear traps
Bear and bull traps are relatively common in the financial market. Indeed, most day traders go through it every day. Let us look at some of the ways of avoiding these traps.
Use limit orders
There are two main types of orders in the financial market. There is a market order and a pending order. The main difference between the two is that the market order is usually implemented right away while a limit order is usually implemented when a certain level is reached.
While market orders are usually good, they have their risks.
Therefore, we recommend that you focus on limit orders, which are conditional. For example, assume that a stock is trading between the narrow range of $10 and $12. In this case, you can place a market order when it rises to $12.50.
However, this could be a bull-trap.
Therefore, at this stage, you could place a buy stop trade at $13, which is an important level of resistance. In this case, the trade will be initiated only when it rises to $13.
In addition to a buy stop, another popular type of a limit order is known as sell stop. In it, you direct a broker to short a company below the price. In the above example, you could place a sell stop at $9. This means that the short trade will be initiated only when the price drops below this level.
Overanalyzing market conditions
Another concept that can lead to a bull or bear trap is when a trader overanalyzes an asset. In most periods, traders who succeed in the market are those who use a systematic approach of analysis. For example, they often use a simple approach to fundamental analysis.
When it comes to technical analysis, these traders use just a few indicators. Some expert day traders use just one indicator like MACD or the VWAP instead of over five. When you over analyze, there are signs that you will get information overload, which will not help you make a good decision.
Avoid putting all your money in one trade
One way of avoiding traps is to ensure that you are not putting your money in one trade or asset. In other words, you should work to have a diversified portfolio.
In this, you should have in mind the concept of correlation. For example, if you place a buy trade on stocks like Chevron, Exxon, and Marathon, chances are that your trade will be profitable if the price rises. You will then lose money if the stocks drop since they usually move in the same direction.
Use multiple technical indicators
Another popular way of avoiding limit orders is to use several indicators in your analysis. For example, instead of using just the moving averages, you can combine them with others like the Relative Strength Index (RSI) and the Money Flow Index (MFI). This will help you confirm whether there is a break-out or not.
If you are new to day trading, we recommend that you spend a few months learning about the best indicator combinations.
Use volume
Another way of identifying bull and bear traps is using volume. Fortunately, many online brokers provide tools to view the amount of volume in the market.
At DTTW, since we have direct market access, our traders are always able to see this volume in real time. Ideally, when a breakout happens, it needs to be confirmed by volume. However, if there is a breakout that has no volume, you should always consider it to be a false breakout.
Develop a good trading plan
Above all, you should work to develop a good trading plan that is holistic. A good plan should have several important parts. For example, it should have the assets that you want to trade. These assets could be stocks, forex, and commodities.
Second, identify the type of trader that you are. In this, you might be a scalper, a normal day trader, or a swing trader. Third, identify the approach that you will use to trade. Finally, have a good risk/reward ratio and a good risk management strategy.
External Useful Resources
- Causes of Trader Failure: Mind Traps – Daytrading Psychology