Bear trap catches the shorts in soybeans looking the wrong way

Without news to explain the sudden turn, shorts may 
at first misjudge the turn as being merely a rally

Soybean prices have continued to trade in a sideways to slightly higher trading range since November 2012. Support is down at $14 and resistance up at $15.30.

This $1.30 trading range is indicative of a market in equilibrium for the past seven months, with few buyers willing to pay more than $15.30 and most sellers unwilling to accept less than $14.

The exception was a quick sell-off to $13.55 in early April, which proved to be a fantastic buying opportunity, as prices slipped below $13.95 and ran sell-stops driving prices down another $.40 per bushel.

The news was bearish at the time, as the record South American soybean harvest was wrapping up, which left some traders looking for additional weakness.

However, this was nothing more than a bear trap.

As the name implies, a bear trap catches the bears looking down at the bottom. Bears, who are also referred to as shorts, are market participants who are expecting lower prices.

When prices fail to have any follow-through weakness and turn back up, the shorts are caught having to buy back their positions to protect their profit or to cut their losses.

Market psychology

It takes an experienced eye to anticipate the formation of a bear trap, but the action of the market participants caught in a bear trap is easy to predict. Since the market is likely to be in a vertical fall prior to its development, we find the shorts are making money and the longs are being wiped out.

With this chart pattern there is hardly any room in between. When the turn comes, the psychology of the market instantly turns 180 degrees.

At the bottom, the shorts are reaping profits and the longs are being battered. Suddenly, and without any hesitation, a dramatic shift in psychology drives the shorts to cover (buy back) their positions. They find that they have plenty of company, as potential new longs also want in. Emotions probably run higher in a bear trap than in any other chart formation.

When the pattern occurs in the absence of any news or explanation it could initially be less dynamic, but the motivation to preserve profits quickly takes hold. Without news to explain the sudden turn, shorts may at first misjudge the turn as being merely a rally.

With profits on the books, they are going to wait and see what happens — a big mistake! The market is propelled higher by aggressive new longs and suddenly the race is on, with shorts trying to make the best of a rapidly deteriorating position.

As illustrated in the accompanying chart, soybean prices rallied for six consecutive weeks and gained nearly $2 per bushel without any significant bullish news.

Not only was this a bear trap, but a reversal pattern called a two-week reversal also materialized at that time, which gave further substantiation of an impending rally.

On the first day (at a low) the market advances to new lows, but closes very weak, at or near the low of the week. The following week, prices open unchanged to slightly lower but cannot make additional downside progress. Quantity buying appears early in the week and prices begin to rally. By week’s end, the market rallies to around the preceding week’s high and closes at or near that level.

Reversals on weekly charts usually signify turns of intermediate importance. However, when they appear as part of larger, more important reversal formations, such as a bear trap, their significance is greatly enhanced as a leading indicator of an impending trend change.

This is a classic example of how chart formations, such as bear traps and two-week reversals enable savvy traders and farmers alike to cut through the news, which can sometimes have them looking the wrong way.

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