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The creation of a bear trap involves the careful planning and execution of a set of circumstances in which there is sense of an impending short term fall in the price of a given security that will be followed by a long term upswing in the price. Essentially, the bear trap is designed to encourage investors to buy at a higher price, with the anticipation that during the upswing the unit price will exceed the rate that was paid for the shares.
A bear market in and of itself is an environment in which there is a high amount of pessimism about the market performance of selected securities. There is an expectation that the market is going to fall, and that is going to lead to a situation where investors will sell short in order to cover the anticipation of loss. Activity in this sort of bearish market means the opportunities to purchase additional shares can be quite good. However, the risk is that the market value will remain constant or continue to fall. When that situation occurs, the investor stands to not make any money from the investment, or possibly lose money.
By the same token, the bear trap also has the potential for creating a great deal of revenue for the investor. Should the buyer happen to acquire the shares early on in the process, it is possible to pay prices that, while higher than the current market value, will still be significantly lower than the final price before the fall begins. This increases the chances of the stock price eventually rising to a level that will justify the purchase price, and moving on to a stock price that results in a great deal of profit.
Another consideration of the bear trap is that the situation can result in the creation of a phenomenon that is referred to as the bear squeeze. Essentially, a bear squeeze results when the investor has to pay a price for the stock that will be difficult to make a profit on when the value of the stock levels off and begins to increase once again. When the investment turns out to produce a loss or even just barely breaks even, the situation is referred to as a squeeze. The investor may feel compelled to sell off the acquired shares, thus eliminating any chance that further adverse conditions will create even more financial loss. Thus, choosing to begin the process of a bear trap should be entered into with a clear understanding of the risk of not only initial loss, but also further financial losses down the road.
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