|  AUG 1992

Avoiding Bull And Bear Traps by Nauzer J. Balsara, Ph.D.

Avoiding Bull And Bear Traps by Nauzer J. Balsara, Ph.D. Bull and bear traps are gap openings that are reversed the same day and that can cost a trader dearly. S&C contributor Nauzer Balsara presents his method of analyzing market history to calculate the proper placement of stops to avoid being caught in such traps. A bull or bear trap occurs when a market does an about- face after an extremely bullish or bearish opening, leaving a trader who entered a position at the opening price with a possible loss at the end of the day. Bullish expectations are reinforced by a sharply higher or ""gap-up"" opening, just as bearish expectations are reinforced by a sharply lower or ""gap-down"" opening. A bull trap occurs as a result of prices retreating from a sharply higher or gap-up opening; the pullback occurs during the same trading session that witnessed the strong opening, belying hints of a major rally. A bear trap occurs as a result of prices recovering from a sharply lower or gap-down opening; the retracement occurs during the same trading session that witnessed the depressed opening, confounding expectations of an outright collapse. BULL AND BEAR TRAP EXAMPLES An illustration of a bull trap is provided by price action on December 3,1991, in July 1992 Chicago wheat futures (Figure 1). On December 2,1991, July wheat settled at 324.75 cents a bushel. A trader, noticing a strong uptrend in the July wheat chart, might not hesitate buying wheat futures at the gap-up opening price of 340.00 cents on December 3. However, instead of prices moving higher, they worked their way down to a low of 328.50 cents, bridging much of the 15-cent gap on the opening before settling at 330.50 cents.

by Nauzer J. Balsara, Ph.D.