Jun 16, 2022
8 mins read
This will probably be one of the most useful tutorials for days to come in crypto, as it has already been really useful for every single trap this year.
Imagine the situation: you're at home, waiting for an opportunity to jump into your favourite coin or what you consider a good investment. Suddenly, the market starts going up. You check Twitter, and almost everybody is bullish. You check prices, and the coin you want is up in the last hour.
How do you know if this is a sustainable rally or just another bull trap? The answer: timeframe, volume and momentum. Let's check some examples:
These are just the last 3 times we identified a bull trap, but we have been warning about fake rallies for months now and every time it was the same:
- An asset (Bitcoin in this case) pumps
- Most people get overexcited and jump into the "rally"
- The "rally" ends in less than 24 hours and a lot of people end up losing money
Every time you want to know if a rally will succeed for more than a few hours or not, the first thing you need to know is that you should wait. You won't be able to identify a fake rally properly if you use 15/20 mins, 1 hour or 2-hour timeframes, because one of the main components of a fake rally is lack of volume, and volume takes time.
Once you're sure you're working only on 4H, 8H, 12H or 1D timeframes, we can continue to add the indicators that will help us to identify if this is a trap or not. I usually use 4H or daily timeframes, which I have found are the most reliable at least in my experience.
We're going to add then some volume indicators, which in my case are Volume (the most popular indicator and the default one for any chart), Volume Oscillator, and OBV (On Balance Volume). You can find them all just by doing a simple search in a TradingView, even if you use a free account.
I suggest keeping Volume in a separate panel as it's easier to visualize and changing the Volume indicator settings to be shown as a line and not as bars because it will allow you to identify the volume trend faster:
Your chart should look something like this after correctly setting up everything. For this tutorial, we'll focus on the daily chart first:
Now we have the daily chart, with not more than Volume, Volume Oscillator and OBV. You can find more information about these 3 indicators here:
- Volume
You can also use any other volume indicators, these are just my favourites. I use Volume and Volume Oscillator to understand volume trends, and OBV to understand institutional interest.
What I want you to do is to keep an eye on and write down the dates where we saw these rallies or big green candles:
- May 30th 2022
- June 06th 2022
- June 15th 2022 (not so big, but everybody was ultra bullish again)
Did you write down the dates? Then collapse the main panel and keep only the volume indicators. I used a vertical line to mark these key dates so it's easier for you to understand what I'm about to say:
Look to what happened with the volume on the dates where we saw a "rally": if we look at these charts on a daily timeframe, we can see there was an increase in all volume indicators:
- from May 30th to May 31st all trendlines went up
- from June 05th to June 06th, the same happened, even with a more aggressive increase if we look at the Volume and Volume Oscillator
- from June 14th to June 15th all 3 volume indicators went up
An increase in volume can happen during a rally but also during a selloff. It doesn't tell us anything about the price, is just a measure of how many participants were in the market at a certain moment, so we won't understand if this rally is a trap if it's an intraday bull trap.
A daily timeframe is useful when you're analyzing potential traps that last a whole week, but I wouldn't call that kind of price action a fake rally. Most of the time when we talk about a fake rally or bull trap we're talking about what happens on the same day or from one day to another like in these 3 cases where everybody gets bullish, they start shouting to their neighbours, friends and family members in their faces that the bear market is over and then... reality arrives.
Let's change to the 4H timeframe and see what happens, and I'll focus on the rally from June 6th where this is more clear:
You can see that while the price was going up during the day, both Volume and Volume Oscillator were going down, and that's your first and most important warning, as this is often known as a Bearish Divergence: Volume and Volume Oscillator should rise during a price rally and if you analyze the volume trend (not the individual spikes, the trend) you can see that's not happening.
Another example here is a bit more difficult to see but I'll help you with it. This is the June 15th rally, can you spot the divergence?
Maybe if I add some drawings...
Once again, the daily timeframe was not so clear, but when we turn to a 4H chart we can see that price is going up while 2 different volume indicators (Volume and Volume Oscillator) are going down. There you have another Bearish Divergence, the volume is showing you what will happen later with the price. In other words, it's telling you "this is not going to last".
What happens with OBV (On Balance Volume)?
In this case, we should trendlines to confirm (or not) a breakout and I suggest focusing on a daily timeframe. I will leave now just the OBV to show you what I mean. For OBV you want to expand the panel so it's easier to work with, and you want to analyze OBV as if it was the price chart, meaning that you'll find supports, resistances and you'll use trendlines:
- During the first rally (May 30th) OBV was going up, but if you trace resistance lines, you can see that it was still below resistance, meaning that it was that line (the green line) where it could retrace.
- During the second rally (June 06th) OBV broke the uptrend (yellow line) and start going down (bearish divergence)
- On the last rally (June 15th) OBV was again in a downtrend while the price was going up, and that's another bearish divergence.
I give OBV more weight than the other volume indicators as it does not reflect just any volume, but primarily volume coming from large or institutional investors. If you see for example that the price goes up, the volume and the volume oscillator go up, but the OBV goes down, I would still consider the possibility that it's a trap since, without the large investors, the retail investors in crypto are not as strong enough to sustain a rally by themselves.
Are these the only indicators that I use to confirm a bull trap or fake rally? No.
I also always check at least one or two momentum indicators to see if they are consistent with the upward price action. Most times I use the Relative Strenght Index (RSI) and Stochastic (STOCH), which are two of the most popular indicator to understand this:
In the 3 cases we analyzed, you can see that Stochastic was oversold or going down, and RSI was below the 50% line or by the floor. All these were also bearish signs during a rally.
In the end, is not about one magical indicator, is about learning how to read multiple indicators and find confluence between them to understand if the current price action is sustainable or not. Always take your time, don't jump into any rally immediately, check volume, wait some hours, check volume again, then check momentum, draw some lines and use a scoring system:
- If you analyze 10 things and 7 are telling you that this could be a trap, it will probably be.
- If you analyze 10 things and 5 are telling you this could be a trap, it's time to wait and see
- If you analyze 10 things and more than 5 are telling you this rally could be sustainable, always remember what's the main trend, as markets usually sooner or later follow it. Translation: if we're in a huge downtrend, it takes much more than a few green candles to break that impulse.
One last word on fake rallies or bull traps: sometimes it is a matter of common sense. The last trap was on the same day the FED announced they will be raising interest rates by 75bp. The FED's raising interest rates has never been good news for high-risk markets like stocks and crypto. If you don't know what a hike in interest rates means, at least do some basic research to understand what's happening.
After that ask yourself: are this good news? Should we all be excited about this? Does it make sense to see the markets pumping when what they're saying is that the economy is plunging? Of course, it doesn't. And therefore, sooner or later, the overexcitement will end and the markets will come back again to reflect reality and not just pure speculation. If you focus on the real economy, you'll have a much better understanding of everything that happens in the market in the long term.
Hopefully, after this and with some practice, you won't fall into so many traps from now on.
Have a nice day,
