What is a Bear Trap?

by Investing School on September 10, 2010

A “bear trap,” which takes its name from the “bear market,” indicates an incorrect indication that the rising movement of an index or a stock has started a serious reversal – but it has not. This kind of trap can often be seen when there is a bear market reversal, and short sellers are firmly convinced that the markets will begin a drop back into a waning pattern. In a bear trap, however, when the market actually keeps rising, any short sellers become “trapped.” They are then required to pay to cover their positions… and to do so at higher costs.

Remember that a bear market is a market situation in which the pertinent investment prices are falling, and there is a broad sense of doom and gloom that causes the market pessimism to become something of a self-fulfilling prophecy! As investors come to expect more and more losses in a bear market, and as selling continues, the negative expectations only increase.

However, a bear market is not the same thing as a correction, which is a shorter-termed trend that will generally last less than a couple of months. Remember that while corrections can be a nice time for an investor to discover a market entry point, actual bear markets cannot usually be expected to provide them. In addition, a bear trap can cause a short seller to become caught in a tough situation when working with a bear market, so caution is indicated.

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