What Is Stop Hunting?
Stop hunting is a strategy that attempts to force some market participants out of their positions by driving the price of an asset to a level where many individuals have chosen to set stop-loss orders. The triggering of many stop losses at once typically creates high volatility and can present a unique opportunity for investors who seek to trade in this environment.
Stop hunting is a tactic described in numerous reputable books.
Consider you have a strong fund; you want to buy a company or a lot of shares of a company. These shares are always without any brake in the hand of someone. With advanced mathematics, you don’t even need to know where their stops are.
In order to get these “shares” that are rotting somewhere in someone’s depot all you need to do is go “short” on a specific stock until the price hits a level where you know many people will get rid of them as (and now carefully) you have a lot of literature that tells the “lemmings” when to place a stop at a certain level of “loss”. So, it’s no hard work to figure out a level where enough people get rid of the losing stock.
The same happens in commodities and other markets. The same is in whatever market, certificates etc. Everywhere where you have a limited number of “contracts” but you need to get as many as possible these things happen regularly. It must not be your broker who does this, it’s usually big players who do this.
What people usually don’t realise, this is a game of wolfs catching sheep, and trust me the wolfs know how to catch a sheep.
In the simplest term stop hunting is equal to levels of supply and demand for buy and sell orders. Don’t ever forget that we retail traders can’t see the full order books, commercial institutions are keen on these levels of interest (where the stops are all placed) as it’s high in liquidity. The higher the liquidity the lower their costs of trading and quicker they can get filled and at a better price.
Understanding Stop Hunting
The fact that the price of an asset can experience sharp moves when many stop losses are triggered is exactly why traders engage in stop hunting. The price volatility is useful to traders because it presents potential trading opportunities.
For example, assume that ABC Company's stock is trading at $50.36 and looks as though it may be heading lower. It is possible that many traders will place their stop losses just below $50, at $49.99, so that they can still hold onto the shares and benefit from an upward move while also limiting the downside. If the price falls below $50, traders expect a flood of sell orders as many stop losses are triggered. This will then push the price lower and give some traders the opportunity to profit from the decline and perhaps even open a bullish position on an expected rebound to the previous range.
Stop Hunting and Stop-Loss Orders
Stop-loss orders are types of orders that are slightly more complicated than a traditional market order or limit order. In a stop-loss order, an investor will place an order with her broker to sell a security when it reaches a certain price. For example, if you own shares of company XYZ Inc., currently trading at $70, and you want to hedge against a significant decline, one option would be to enter a stop-loss order to sell your XYZ holdings at $68.
If XYZ moves below $68, your stop-loss order is triggered and converts into a market order. Your XYZ holds would be liquidated at the next available price. Stop-loss orders are designed to limit investors’ losses on a long position. A stop-loss order can protect a short position as well.
Finding the Stop-Loss Orders While Stop Hunting
Stop hunting is relatively straightforward. Any asset with significant enough market volume will be moving in a more or less defined trading zone with areas of support and resistance. The downside stops losses tend to be clustered in a tight band just below resistance, while the upside stop losses sit just above support. Larger traders looking to add to or exit a position can shift the price action with volume trades that amount to stop hunting due to their market impact.
Generally, this will be signalled on the charts by increasing volume with a clear directional push. For example, the price action might bounce off support twice on the increasing volume before breaking through. Smaller traders jump on this stop hunting behaviour to realize profits from the volatility it creates in the short term. Depending on your strategy and indicators, you can participate in the stop hunting on the downside with a short position or consider it an opportunity to open a long position at a price lower than the recent trading range.
There are two aspects of “stop hunting”. One is the dealing desk brokers who take opposite trades of you (your loss is their win) and they can manipulate the price to catch your stop loss. You can investigate this if you compare several brokers and see how the price behaved at that point (if other brokers have no spike, then it’s quite possible your broker manipulated the price).
The second aspect are the market makers and dealers who basically push the price to where more people have pending orders (they can see where stop loss/take profits are). They mostly profit on traded volume than if a particular trader loses or wins so it’s in their interest to move the price to where more traders are willing to participate.
However, you should note that as eddies said there are many traders and funds, and many companies buying and selling stuff around the world, there are central banks and governments buying/selling reserves. Therefore, the price can be manipulated in small pips rather than entire trends which are basically moved by central bank’s policies and/or supply and demand.
How Smart Traders Mess Around with You
The Bull and Bear Trap
Making traders take trades in the wrong direction is a very simple thing to do and you have noticed it before as well, without being aware of it. Let’s say you want to buy a support level after price drops back into it. Often, you’ll see the price going through the level and it looks like the level isn’t holding and the price is breaking out.
This scenario is ideal for smart traders. First, those traders who have prematurely bought a potential bounce off support see price heading for their stops (which are essentially sell orders). And second, the other traders who have waited patiently are now looking to sell the (fake) breakout. The average, retail traders are now all happily selling to the profitable traders who are even more happily buying from them for a very good price.
Because of the high demand from the profitable traders, prices will rise and now take out the stops from the traders who sold the fake breakout – which is accelerating the bullish move even more. The traders who are now left with profits are, as usual, the smart traders. The frustrated losing traders will see that their initial idea of buying support was correct and they are left thinking that it wasn’t such a bad trade after all – probably just some “weird” and “messy” price move. “Next time it should work again”, they think… It will, but not for them!
Triggering Your Greed and Fear Responses
This price behaviour is another amateur-trap and it works similarly to the Bear and Bull Trap. But the way it plays out on your charts is slightly different and therefore, worth pointing out.
Let’s say the price is currently at 110 and keeps falling towards the very big support level at 100 where you, and probably 90% of all other traders, want to buy. Very often you’ll then see a reaction ahead of the level. When price starts twitching at 102 and starts moving up a few pips, the impatient amateur traders will get very nervous and fear that price has already found support and will take off without them. We traders are a very greedy bunch of individuals and we hate it when price misses our orders by just a few pips. The profitable trader knows this and will use it to their advantage. Therefore, amateur traders will prematurely pull the trigger and take a long trade even if the price hasn’t come to the actual support level yet.
The smart and profitable traders can now drive price further down, generating panic among the long-positioned traders and then buy back from them when they exit their trades because they think the price is breaking down. The result is similar to the one of a Bear Trap, with the difference that the way of tricking amateur traders into losing trades is slightly different.
How to Avoid Getting Tricked into Taking Losing Trades
Those are just 2 examples of how losing traders get tricked into making wrong assumptions about price movements, but if you can understand the psychology and think behind them, you’ll be able to understand the drivers of price action and the herding behaviour, in general, a lot better.
Tips on How to Avoid Stop Hunting:
- Don’t use the obvious levels for your stops. Big round numbers are a very bad choice for picking your support and resistance levels.
- Research shows that exchange rates trend faster after crossing round numbers suggesting that stop-loss orders propagate trends.
- Stop-loss orders are tightly clustered near rates ending in 00.
- Add your spread + a few pips of extra padding to your stop. The padding is key!
- The more people talk about a certain level, the harder it is to profit from it.
- Add a column in your trading journal and keep track of how far price moves against you. This is an excellent way to see if you enter too early or place your stops too conservatively.
- Get in the heads of the average retail trader. It’s usually very easy to figure out what they see on their charts and want to do. Then do the opposite.
- Use confirmation criteria in your trading as an extra filter
- If a trade is too good to be true, it’s too good to be true
You
should Trade Less But Trade Accurately & this is Achieved with our Tip.
