Stop hunting, otherwise known as stop loss hunting is one of the major tools big institutions use in market manipulation. Experienced and inexperienced traders are alike when it comes to falling prey to stop hunts.
There are instances in the forex market; where you might have seen a trade you were highly certain about at a critical level. You then took a position only for the market to move against your position; hit your stop loss and move back towards your original position to take off without you.
Painful right? There is a high chance that; you might have been a victim of the stop loss hunting phenomena.
Stop hunting affords big institutions an opportunity to manipulate the market; by pushing prices in a direction where they can trigger the stop losses of other traders for their own gains. Retail traders are the largest prey to stop hunting, since most victims fall in this category.
Big banks, hedge funds, high net worth traders are some of the big guns that participate in stop hunting. Many traders also suspect that some brokers involve themselves in this phenomena; though it makes little sense that a broker would do this to lose clients.
How stop hunting materializes.
These big institutions have access to critical data as well as special algorithms that help them to manipulate the markets in their favor. Stop hunting is every retail trader’s nightmare and though unavoidable, it can be minimized.
By gathering data on where the herd of traders have placed their stop losses, the market manipulators push prices the way of the stop loss levels. Eventually the stops are triggered and this causes massive market movements and big spikes in price.
The herd of traders place their stop losses at psychological levels and some obvious levels including swing highs, swing lows and right below or above key support and resistance levels. Due to this simplicity of placing stop losses, it is not usually hard for the institutions to find where the stop losses are.
It may be harsh but it is ethical.
Stop hunts are one of the many ways by which liquidity can set into the market. This cannot be effected by the retail market.
Retail traders have it simple and easy in terms of buying and selling due to the fact that, they do not control a huge amount of money. It usually takes some seconds to enter trades under the right conditions.
Institutional traders do not have that luxury since they trade thousands of lots. They enter trades gradually at relatively different levels in order to avoid slippage. For that matter, they need the necessary liquidity and volatility to advance their trades.
Stop loss hunting creates liquidity as well as volatility.
Liquidity and volatility is one thing retail traders cannot provide since the retailers capital is not high enough. By hunting for stops losses liquidity and volatility can set in tremendously when the stops are triggered.
This is made possible because the forex market is traded simultaneously; a buy position’s stop loss would sell a currency pair and a sell position’s stop loss would buy a currency pair if triggered.
Stop hunts give better prices.
Another reason why stop hunting happens is the bargain for better prices. The old code trading rule of buy low and sell high influences the big players to drive prices higher only to sell and drive prices lower only to buy in order for them to get good entries.
It may not sound fair to the average person but if you consider the topics of liquidity, volatility and better prices, stop hunting in some way is beneficial to the movement of the market. Trading is a zero sum game; this means for one trader to win, another must lose and vice versa.
Only the fittest survive. The forex trading environment is like that old joke about a bear that is chasing two people; “You don’t have to run faster than the bear to get away. You just have to run faster than the guy next to you.”
In order for you to lose, someone must win and in order for you to win someone must lose. Such is the reason for stop hunting; your stop loss order could be the entry order for the big players and other experienced traders.
How to avoid falling victim to stop loss hunting.
It is impossible to avoid falling victim but there ways you can devise to minimize the times you fall victim. Knowing the problem is a big part of the solution even before putting in the action. Once in a while you will fall victim and there is nothing you can do about it.
As you already know, the big market players target psychological levels and obvious levels such as swing highs, swing lows as well as key support and resistance levels. The first solution is to identify these levels before hand and avoid setting your stop losses there.
Use wider stops.
Many traders who fall victim to stop hunting are fond of setting tight stop losses. This gives the trade no room to go negative for a while if a position is to move against you. Stop hunting may come in the form of quick retracements and that may just take you out of position and take off without you later on.
Tight stops may come as a result of risking too much. It is more beneficial to cut risk into half and use a wider stop loss to give your trades, breathing space. When you do it this way, only a true reversal of the market will take you out of position. See this post to see how to set stop losses the right way.
Wait for the retracement/pullback.
In the pictorial examples above, it is obvious that the stop hunts came in the form of pullbacks to breakout levels. Picking market tops and bottoms is for the aggressive trader and for the big player as well. If you are not very sure, you can trade conservatively and only make your moves after the big moves have taken places.
After the big moves take place, pullbacks may follow and they are more common than you think; so why not wait and trade them rather? Once you know that stop hunting may take the form of quick pullbacks, then you know what to do already.
I will end here by saying not setting stop loss is not a wise way to avoid stop hunts; and I hope this lesson about market manipulation with stop hunts have been an eye opener to you to an extent where you find it helpful. Let me know what you think in the comment box below.