Bear Traps - a great bull signal

Summary

• Bear traps are an underrated bull signal.
• A bear trap occurs when price breaks through a support level but quickly reverses.

---

Bear traps occur when price breaks through a significant support level, but quickly reverses when stops triggered are mopped up by ready buyers. Recovery above the former support level completes a bear trap reversal.

A bullish divergence on a sentiment indicator like Twiggs Money Flow or Twiggs Trend Index strengthens the bear trap signal.

The bear trap is a great trading opportunity, with a sizable win-loss ratio if you place a tight stop-loss below the previous support level. Set a target at the next significant resistance level or — if the bear trap occurs in a strong uptrend with the prospect of a sizable advance — use a trailing stop-loss to lock in profits.

Example: All Ordinaries Gold Index

Australian gold miners have recovered from their recent sell-off, with the All Ordinaries Gold Index ($XGD) testing resistance at 13,250. A breakout would offer a long-term target of 15,000.

The latest rally confirms our long-held view that a bear trap (red circle) is a vastly underrated bull signal. Breach of long-term support at 11,000 sparked a sell-off as stops were triggered, but strong buying in early August completed the bear trap with a recovery above 11,000. The signal was strengthened by a bullish divergence on Twiggs Trend Index, completing a higher trough. Having flushed out the bears, the index climbed steadily through August and now threatens a new high above 13,500.

Place a tight stop-loss below the previous support level at 11,000. With a weak-trending stock, we would sell when price reaches our target of 12,000 — the next significant resistance level. However, due to the strong long-term XGD uptrend, we use a trailing stop-loss to lock in profits as the index advances.

Conclusion

The recent break of the All Ordinaries Gold Index ($XGD) below 11,000 supports our view that bear traps are a vastly underrated bull signal.