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And as always, start your analysis by zooming out so you get a good view of all the structures and areas on a chart where you might find some trap traders. One of the major keys to trading traps successfully is to understand where about on a chart these occur and what was happening prior to the trap setting. So, the context pre-trap is extremely important.
In this example, you can see that prices have been selling off strongly, making a series of lower lows and lower highs. This is the perfect environment for some great trading traps because at the hard right edge, this price action would’ve been very eye-catching and that’s precisely the type of trading that gets reactive traders very exciting about entering the market.
As you can see, I’ve applied the Fibonacci retracement tool to this lower leg of the price action. The reason I’ve done this is because I’m looking for areas on a chart where retracement traders get trapped on the wrong side of the market. So, if we walk through the logic of this trade, price had been selling off strongly, making a series of lower lows and lower highs. As it pulls up in this area here, price hits the 23.6 percent Fibonacci ratio and it looks as if it’s having some trouble closing above that level. A spinning top is an indecision candle, and if I was looking to sell down here off this Fibonacci level, this trade will be starting to get interesting.
The next candle closes negatively and creates a swing point in price, denoted by this high in price, which is then surrounded by two lower highs. So, at the hard right edge, trading Fibonaccis, this will be starting to look like a great entry. So, the reactive trader would’ve entered at the hard right edge. However, as price develops, it starts going against the position and traders in and around this area here, who would’ve sold, are now starting to lose money.
But we do see a bit of a reaction off the 38.2 percent Fibonacci level, and because of that, it might mean that these traders down here will hang on to those trades a little bit longer to see if we do indeed get the follow through that they’re hoping for. So, at the hard right edge in real time, this would’ve looked like the 38.2 percent held, as it was struggling to close above it and then sells of strongly, and this wick would’ve looked like we were off to the races to the downside.
However, no sooner did people get drawn in, price reverses and closes above the 38, trapping those traders short because in real time that candle would’ve looked very negative. Now we have two groups of Fibonacci traders who have been caught off siding this trade and they’re starting to probably wonder if this trade is going to work for them or not. And because price failed to make a new low, they’ll be feeling the pressure of their losing position.
Now, if traders selling within that red box and the traders who sold earlier at the 23 percent get an opportunity in the future to bail out of those positions at break even, the likelihood is they’ll do so, because the second best trade is a scratch trade, and their expectations have adjusted from when they first entered the trade, which would’ve been profit. It’s now just about getting out without a loss, so their mentality has adjusted. And if those traders sold down there, then in order to exit those positions, it’s a buy transaction that must occur (i.e., demand).
So, price continues against them, and just imagine their psychology when price is at this point on the chart here. How is life working out for them? Not very good. Imagine they’re taking too much risk. They will be desperate to liquidate those positions. And as price trades back into this area, it’s no surprise to see price pop up, because the traders who were trapped in here have to buy to exit, creating an opportunity for the savvy trap trader protagonist.
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