For a trader, there is nothing more depressing than taking a loss. To make matters worse, the market will often move in your direction immediately after your stop loss is triggered . Many traders believe that their broker or some other external force may be specifically hunting for their stops. I will try to debunk some of these trading myths and give you some tips on how you can reduce your stop loss trails.
Stop hunting: what is it?
One of the most widely held myths in the forex market is stop hunting. Most traders have experienced a similar situation where it seemed like their stop losses were deliberately hit by a broker, market maker, or some other outside force.
The stop loss hunting phenomenon describes a scenario in which you enter a position and set a stop loss price. Some time later, the price hits your stop loss, taking you out of the trade. Then, almost immediately after, the price reverses and moves in the direction you intended.
Anyone who has experienced this can vouch for how frustrating it can be. And the worst thing is that this situation is not a one-time event, but happens quite often in the financial markets, especially in the forex market.
As a result, this leaves traders wondering if they are just a victim of bad luck or if there is some kind of conspiracy in the market that is working against them. It is widely believed among traders that these actions are not carried out by their brokers, who may be taking the other side of their clients' order flow. We'll look at later if this is a legitimate concern or just a myth being blown up.
So why would any market participants engage in stop hunting? If you understand the concept of market liquidity, it will help you understand why such events occur. Unlike most retail traders who only trade relatively small volumes, larger market participants such as hedge funds rely on large amounts of liquidity to get in and out of the market efficiently.
Thus, the smart money regularly scans the market for areas of liquidity they can use to help fill their order flow. These participants are very familiar with where and how most retail traders place their stops. Thus, they may seek to temporarily move the market in an attempt to find the necessary liquidity to offset their position.
Many see this type of smart money activity as market manipulation. However, you must understand that there is no collective concerted effort to make your position in the red. Instead, you should take the time to gain a deeper understanding of the mechanisms behind these market movements.
When you can put yourself in the shoes of the big players who can move the markets, you will be able to better understand why such manipulations occur. And more importantly, you will learn how to avoid becoming the victim of a stop hunt or liquidity buildup.
Do dealing desks track your stop losses?
The vast majority of dealing brokers do not track your stop losses and do not deal with them. In this case, there may be unscrupulous brokers who can unfairly hurt your stop losses. As such, it is imperative that you work with a reputable broker that is well regulated. This will be your best defense against unethical trading practices that can take place in small unregulated jurisdictions.
For the vast majority of regulated brokers, it makes no sense to risk such fraudulent practices as it can result in heavy fines and even loss of their license. And not to mention their reputational damage in business.
At times, your broker may appear to be targeting your stop loss or manipulating spreads . Sometimes we can feel that some grand conspiracy is working against us in the market. And it is the broker that is the main manipulator in the market.
As I noted earlier, what may look like market manipulation and stop loss hunting is actually a liquidity rush initiated by the smart money in an attempt to fill their orders. This is the more common and plausible scenario that you should focus on instead of putting the blame on your broker.
Obviously, you should take the necessary steps to avoid falling victim to the smart money's liquidity drive, but at the same time, you must also be responsible for your actions in the market. In many cases, it is much easier to put the blame on others, including our broker, other market participants, or some other mysterious force, than it is to introspect and sort out our own failures.
With any type of new knowledge, you must first understand the underlying logic. Only after you do this and accept it, you can move on to using the knowledge gained to your advantage. You have now come to the conclusion that the real threat to your stop loss is not your broker, but rather the result of the actions of certain market participants. Let's see how you can protect yourself from such market manipulation.
How to protect yourself from hunting for stops?
As traders, we know that one of the best defenses we have is stop loss trading. But how can you avoid falling into the trap of stop hunters? Luckily, there are some techniques you can use in your trading that will help minimize these occurrences.
Let's take a look at some of the best practices you can start using right now.
Use the ATR indicator
The ATR indicator , short for Average True Range, is based on volatility . It is very useful for measuring current market volatility. We can use this indicator to help us better evaluate the optimal stop loss placement.
In essence, the ATR indicator gives us an idea of the average range of the market. We can take a multiple of the ATR and use it to measure the distance from the stop loss to the entry point. For example, if the current ATR on the EURUSD daily chart is 100 pips, then we can set our stop loss to 1.5 times that range. So in this case our stop loss would be placed 150 pips from the entry point.
Below is an example of the ATR indicator plotted on a daily chart.
Avoid obvious areas
The more obvious a support or resistance level is on a chart, the more likely it is to be used as a manipulation zone to gain liquidity. Keep in mind that if you see an area that is perfect for a stop loss, other traders will likely also think the same. Thus, these traders also increase the number of stops in this area. Smart money looking for liquidity flows in the market can absorb these types of orders very quickly and efficiently.
These stop losses create a pool of liquidity that they can use. Therefore, it is important to try to place a stop loss at levels that are not easy to find. We should not merge our orders with majority positions. Instead, it is much safer to use a wider stop loss that goes beyond the obvious levels.
Use Multiple Stop Losses
Scaling your positions is a technique that many professional traders tend to do. However, most retail traders have a "one position entry" or "complete exit" strategy. While this works in many cases, you can see an improvement in your profits by breaking your stop losses and cutting back on your trades.
This is definitely an exit strategy worth checking out. This can reduce the risk of all your stop losses being hit as your stops are spread across different price levels.
Detection of sharp price rebound zones
Market reversal is most often found near clear support and resistance levels. Thus, we see how a clear level breakout turns into a false breakout .
On a candlestick chart, this activity forms very specific candlestick patterns, such as a pin bar or engulfing pattern on a failed up breakout, or a pin bar on a failed down breakout. It is important to watch these types of reversal candlestick patterns for signs of potential market manipulation.
What strategy can be used to avoid stop hunting?
Now that you understand the psychology behind market movements, you can take steps to protect yourself from these price movements that could negatively affect your position. Also, once you know what stop hunting patterns look like on a price chart, you can build a foundation to join the smart money and take advantage of those fluctuations.
You have to start putting yourself in the shoes of big organizations and big money players. These institutional structures are constantly looking for pools of liquidity to fill their positions in the market. Smart money players seek to build liquidity, especially in the area of easily recognizable support and resistance levels, which are closely monitored.
The stop loss strategy below works best on a daily chart .
- Look for an obvious support level within a certain rectangular range.
- Wait for a break below the support level and let the candle close.
- If the breakout candle looks like a pin bar with a strong lower shadow, we will be preparing for a potential long position.
- A buy order will be placed 1 pip above the high of the pin bar.
- The stop loss will be placed below the low of the pin bar.
- Take profit will be placed near the upper end of the range.
Below are the rules for trading a bearish setup:
- Look for an obvious resistance level within a certain range.
- Wait for a breakout above the resistance level and let the candle close.
- If the breakout candle looks like a shooting star with a strong upper shadow, we will be preparing for a potential short position.
- A sell entry will be set 1 pip below the low of the pin bar candle.
- The stop loss will be placed above the high of the pin bar.
- The target will be placed near the lower end of the range.
Let's now illustrate the trading strategy described above.
The first thing we want to look for in a setup is price consolidation . The rectangular pattern has two swing highs and two swing lows. As you can see from the example, there are two relatively close swing highs that make up the upper resistance line of this formation. And we can clearly see two swing lows that can be used to build a support level within the box structure.
Moving on, we will simply wait for a breakout from either the resistance line or the support line. In this case, we can clearly see that the price moved up after making a second swing low within this rectangle and continued up towards the upper resistance line.
As the price nears the upper resistance level, we will closely monitor the price action to look for any potential signs of institutional activity, reminiscent of hunting for stops just above the resistance level.
We need to be patient and wait for a real upside breakout while staying out of the market. Once the upside breakout occurs, we continue to monitor the price action and ultimately wait for the candle to close before further evaluation. If the breakout candle forms a pin bar, then we can prepare to go short.
Now that all of our conditions have been met for a potential short position, we can place our sell entry order. According to our rules, when the price moves one pip below the pin bar, this will be our signal to go short. You can see that the candle actually went below the low right after the pin bar formed.
In this case, the stop loss will be placed on the opposite edge of the pin bar. In particular, it should be placed just above the highest price. Take profit will be set near the bottom of the range.
Summing up
Most of us are aware of the importance of stop losses in trading. But sometimes we get very nervous when it seems that our stop losses are regularly hit. Some traders tend to get paranoid about this, believing that it has something to do with their brokers and trading against them in the market in some way.
As I wanted to show in this article, many of these concerns are exaggerated, at least as far as your broker is concerned. While market makers can see your stop loss in many cases, they don't conspire specifically against you.
This does not mean that there are no market manipulations in the market. While some market participants like to use the term "market manipulation" or "stop-loss hunting", a more appropriate term for such activity is "liquidity recruiting". Major market players are always looking for liquidity to find the necessary order flow to fill their positions.
Once we understand what this activity looks like on a price chart, we can take the necessary steps to avoid falling into such traps, and even exploit them for profit from time to time.