How to Find Trapped Traders and Avoid Becoming One
The concept of trapped traders is very powerful when applied to a trading strategy, and will be one of your most reliable tools for the rest of your trading career.
What are Trapped Traders?
Whether you are a profitable trader already, or on your way to becoming one, you know the feeling all too well.
Your strategy identifies a great long opportunity, so you buy to open a position. Then it happens, price starts moving against you and approaches your stop loss, but you know it will come back – it has to. So you move your stop loss lower, only to see price drop even more. Before you know it, you are far away from your entry and hoping for a come back. You are now officially a trapped trader.
Trapped traders can be either long or short, and are in fact often trapped together in the same location.
Where do you think that location is on a chart?
When you see a range or consolidation in a chart while there is average to high volume, the market is in the process of accumulating enough trapped traders before we can shake out of that area and make another move.
Let’s look at a few examples – and you will be amazed at how much clearer you will see the market after understanding trapped traders:
In the 5M chart below, we are looking at the price of the SP500 index futures.
- Around 7AM, we see a series of highs, but the closing prices were below the 2,128 area
- After selling off to 2,126.50, we make another two attempts to break above 2,128, temporarily looking successful
- You can bet that a ton of traders got long in that break out above 2,128 with the long wick above 2,129 (they were right temporarily, and profitable, but…)
- All those longs were trapped traders! Trapped long to be precise, with stop losses below the 2,126 lows.
- The next 5 min candle is a bearish drop below 2,126, wiping out all the trapped long traders as their stops get cleaned out
- But as soon as we drop below 2,124, prices reverse, and guess what? Now we have trapped traders – this time they are short!
- Looking at the price chart by the end, we have a consolidation between 2,128 and 2,126…. above resistance we take out the trapped shorts, and below we take out the trapped longs
- Consolidations accumulate open positions long and short, and when too many get trapped we’ll break out of the consolidation to wipe out the stops of the weaker side – rinse and repeat, this is how the market works
We can then see that above 2,129 we got a buy stop run from the new trapped shorts below 2,124 and the new longs above 2,129. This was a head fake rally, also known as a fake-out, before we once again run stops to the downside of the long trapped traders. The long bus was too full.
Once we let a few weak longs off the bus, the trend now has enough cash on the sidelines that is interested to buy back into the trend and the rally extends up to the next target level of 2,124 – where we accumulate more trapped traders. Rinse, repeat.
How to Use Trapped Traders in Your Trading Strategy
There are trapped traders in every consolidation level on a chart. Now that you know how to spot them, you can use them as a support or resistance.
Here is a step by step process to identify trapped levels on your chart:
- Open an hourly chart on your instrument of choice
- Find previous consolidations which price has not traded to or through yet
- Draw a horizontal line in the middle point of that consolidation
- These upside horizontal lines are now resistances (if you are long and locking profits, do it a few ticks below these lines as they do not always hit)
- These downside horizontal lines are now support (if you are short and covering for profit or looking to open a new long, do it a few ticks above the lines)
Final Thoughts –
When a trend starts moving in one direction, a lot of new traders start chasing it higher and buying on the rally, which is usually the precise point that the smart money is exiting their long trades form below and locking profits.
This distribution of smart money to inexperienced money creates a transfer of positions to the new traders. When new traders get trapped, you you know what happens next, their stop losses get cleaned out and we get back down to a support level to do it all over again.
You can avoid being a trapped trader by switching to buying dips and selling rips as opposed to trying to catch break outs.
There are some products which can effectively be traded with a break out strategy, but with computers doing more than 50% of the daily volume, these break outs end up being faded and turning to fake outs more often than a trend extension.
Now that you are not part of the trapped traders camp, you’ll be part of the profitable traders group – a much smaller circle.
How do you avoid being a trapped trader? We’d love to hear from you in our comment section.
You can also learn about our institutional grade day trading package here, or learn to trade a more passive options strategy in our package here.
The information contained in this post is solely for educational purposes, and does not constitute investment advice. The risk of trading in securities markets can be substantial. You should carefully consider if engaging in such activity is suitable to your own financial situation. TRADEPRO Academy is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.