Stop Hunting: How Not to Fall into a Trap
In the world of trading, knowledge is power, and being aware of the strategies employed by market manipulators can be the key to safeguarding your capital. One such manipulative practice is stop hunting, which targets stop-loss orders in an attempt to drive prices in a particular direction. In this article, we will delve into the concept of stop hunting, explore how it works, and detail the strategies you can employ to protect yourself from becoming a victim of this practice.
What Is a Stop-Loss Raid/Stop Hunt?
Stop-loss hunting, sometimes written as SL hunting or termed a stop-loss raid, is a manipulative practice used by some market participants to intentionally trigger stop-loss orders and drive prices up or down. The goal of stop hunting is to force other traders to sell or buy, creating a domino effect that drives prices even higher or lower. Large institutional investors, like hedge funds, investment banks, who possess the necessary resources, often employ this strategy.
Stop raiding can wreak havoc on both traders and investors, potentially leading to substantial losses and undermining market efficiency. To protect your trading capital, it's crucial to recognise this tactic and adopt measures to avoid stop hunting.
Stop Hunting and Stop-Loss Orders
Stop hunting takes advantage of stop-loss orders. To prevent losses, traders and investors often place these orders with a broker, instructing them to buy or sell an asset when it hits a predetermined price. In other words, traders use stops to limit losses by automatically closing their position once the price of an asset reaches a certain level.
Stop-loss orders provide traders and investors with the convenience of limiting losses without constantly monitoring the market. However, this benefit comes with a caveat: vulnerability to stop raiding. Cunning market manipulators use a variety of techniques to trigger these orders, which can result in frustration for unsuspecting traders and investors.
To fully comprehend how stop-loss orders can be exploited to manipulate the market, it's vital to understand how they function. As mentioned, when a trader places a stop order, they essentially direct their broker to execute a trade once the security's price reaches a specific level. For instance, if a trader acquires a stock at $50 and sets a stop-loss order at $45, the broker will automatically sell the stock if its price dips to $45 or below.
Stop-loss orders serve as a valuable tool for traders and investors, allowing them to cap their losses. However, market manipulators may also use them to drive markets up or down.
A large institutional investor, for example, might place a hefty sell order at a level where numerous stop-loss orders lie. This action could trigger those orders, inciting a flurry of selling that drives the asset’s price even lower. Consequently, the institutional investor can purchase the security at a lower price, potentially generating substantial profits.
Identifying Signs of Stop-Loss Hunt
Recognising stop hunting is tricky, as it typically occurs behind the scenes. However, there are some signs to watch out for that may indicate that a stop-loss raid is taking place.
The most obvious sign is a long wick that reaches above nearby highs/lows before the candle closes back in its current range. Market manipulators know that stop-loss orders rest beyond these highs/lows, especially if there are equal highs/lows or a “strong” support/resistance level exists, so these wicks may indicate that stop-losses are being triggered. These wicks most often look like the hammer or shooting star candlestick patterns.
It's also worth noting that stop hunting may be more prevalent during times of high market volatility or low liquidity, as these conditions make it easier for manipulators to move the market. Be extra vigilant during such periods to protect your trades from potential stop hunting tactics.
In terms of your own trading, if you continually notice that your stop is triggered before the price takes off without you, then you may be a victim of stop raiding. If that’s the case, then it’s a good move to consider how tight you’re placing your stop-losses, and employ one of the strategies below to mitigate the chance of your stop being hit.
Stop-Loss Strategies to Avoid Stop Hunting
While it is important to be aware of the potential risks of stop hunting, there are steps you can take to avoid being targeted by this practice. One of the most effective ways to protect yourself from stop hunting is to use stop-loss orders strategically. Here are some strategies you can use to avoid stop hunting:
Strategy 1: Identifying Areas of Stop-Loss Orders
One way to avoid being targeted by stop hunting is to identify areas where there are likely to be a large number of stop-loss orders. You can do this by analysing charts and identifying key support and resistance levels and trendlines. When prices approach these levels, there is often a cluster of these orders placed just below or above these areas.
By identifying these areas, you can avoid placing your stop-loss orders at these key zones. Instead, you can pinpoint levels that aren’t likely to be breached, which may reduce the risk of your orders being targeted by stop raiding. Generally speaking, setting stops above/below areas that caused an impulsive move is a decent place to start.
Strategy 2: Avoid Round Numbers for Stop Losses
Another strategy to avoid stop hunting is to refrain from placing your stop-loss orders at round number prices. For example, if the current price of a stock is $50, you may be tempted to put your stop-loss order at $49 or $51. However, market manipulators may target these levels in order to trigger a wave of selling or buying.
Most of the time, it doesn’t make sense to place stop-loss orders at arbitrary prices. Choose your stops based on technical factors and the probability of the level being reached. You could even choose a fixed percentage as long as you confirm the validity of the stop-loss with technical analysis.
Strategy 3: Use ATR to Measure the Stop-Loss Level
The average true range (ATR) is a technical indicator that can be used to measure the volatility of a security. As the name suggests, ATR is calculated by taking the average of the true range of a security over a specific period of time. Statistically speaking, an asset is unlikely to deviate from its ATR.
By using ATR, you can set your stop-loss orders at a level that considers the security's volatility. This may help you avoid setting your stops too close to the current price, which could make them susceptible to raiding.
For example, if the current price of an asset is $50 and the ATR is $2, you may want to set your stop-loss order at $48. This would give the price enough room to fluctuate without triggering your order. You’ll find the ATR indicator and dozens of other tools waiting for you in the free TickTrader platform.
Takeaway
In summary, stop hunting is a manipulative practice employed by some market participants, such as large institutional investors, to intentionally trigger stop-loss orders and influence market prices. There are even theories that brokers assist these participants in identifying clusters of stop-losses and engage in stop hunting themselves. However, Electronic Communication Network (ECN) brokers directly connect traders with liquidity providers and remove any conflict of interest.
FXOpen is a Trusted ECN broker with your best interests at heart. If you are ready to start trading, why not open an FXOpen account? You’ll be able to enjoy low-cost trading, ultra-fast execution speeds, and the confidence that you’re partnering with Traders Union’s Most Innovative Broker of 2022. Happy trading!
This article represents the opinion of the Companies operating under the FXOpen brand only. It is not to be construed as an offer, solicitation, or recommendation with respect to products and services provided by the Companies operating under the FXOpen brand, nor is it to be considered financial advice.
Read more: https://fxopen.com/blog/en/stop-hunting-how-not-to-fall-into-a-trap/
Text source: Forex Trading Blog
