These reversals differ somewhat from what are called key reversals, the definition of which is an occurrence of a new low (or high), followed by a close above (below) the prior bar’s high (low)—this applies to any period the bar measures, for example, hourly, daily, weekly, and so on.
There will be more on key reversals in the section on chart patterns. The main point is just to note that with a key reversal, the new low or high is in relationship to the prior bar or two (e.g., day or week) and not necessarily to the preceding price swing.
In a bull trap reversal, the rally that takes out a prior high tends to bring in new buying because this often signals a new up leg—another wave or price movement of intermediate proportions. Otherwise, the new high serves to convince those long a stock or other security that they are on the right side of the market. If this rally then fails, by reversing to the downside, it has the effect of trapping the bulls or those with the conviction that prices will keep rising—hence the term “bull trap” or “bull trap reversal.”
An example of a bear trap reversal is shown back in Data , as the weekly chart of International Paper (IP) also provides an example of a bear trap as noted in the lower right. After a prolonged downtrend, there is yet another in a series of new lows and it exceeds the prior low by a comfortable margin—however, this time the lower low was followed by a rapid and good-sized advance. Renewed selling had no doubt come in as the old low was exceeded. Sellers, or buyers who had finally liquidated their positions, would have had expectations of another downswing or another down leg. The bears instead were trapped by the rapid reversal. Of course, they are only trapped as long as they don’t cover (buy back) their short positions, but as I said before, there is often a considerable period of disbelief that a trend reversal is occurring. Remember that prices have to exceed the prior upswing high to confirm a new trend, and prices may have to travel some distance before this occurs.
There are implications of the trend reversals of the type described here as bull and bear traps, that go beyond the significance of affirming that market trends can reverse suddenly, even after exceeding prior lows and highs. Very often, such trend failures and reversals after a lengthy trend, offer excellent opportunities to take a position in the direction of the new trend, as it may be very powerful. Price moves often reach a point of exhaustion, where the forces driving prices in the direction of the trend become spent or come to a conclusion. After almost everyone who is a potential buyer, or potential seller as the case may be, has bought or sold, there are few left to keep the trend going. When there are few or no sellers left, only a modest amount of buying can drive prices back up sharply.
When there are few or no buyers left, a modest amount of selling can drive prices sharply lower. This is what is meant in the saying that “bull markets die of their own weight”—a market that has no group of substantial buyers left, will fall simply due to the removal of new buying and only a modest amount of selling.
Read More : New Highs Lows That Are Followed By Trend Reversal
