If you’re not familiar with stop hunting it’s basically where you place a position on a trade with a stop loss, then the market will trend down take you out and then go back in the original direction which you had been hoping for.
For example if you place a trade knowing that it’s going to trend up, put on your position but observe the market quickly spike down take out your stop loss, take you out of the trade for a loss and then return in the original direction.
A lot of traders get very frustrated about this and it is something that does happen I’ve witnessed it happen several times and it’s happened to me. A lot of retail traders think stop hunting is done by brokers; what they think is that the brokers can see where your position, can see you stop loss is then widen the spreads a little and take you out and pocket the cash.
In reality that is a myth, there may be some unscrupulous brokers in some far flung corner of the world that do practice that, however generally mainstream brokers that are regulated will not, it is very very rare. There are however some people out there that are actively hunting your stops but it’s not your broker.
First things first, why wouldn’t the broker do it; well if we think about it in the brokers best interest for you to be trading profitably. Bear in mind that every time you make a profitable trade they get commission, to simplify it every time you take a trade the broker takes a pip or a fraction of the spread. If you are a very good trader who makes regular, consistent profits in the market, each time you take a trade, that broker makes a commission either directly or by adding a little bit onto your spread. This means, therefore, that the more you trade, the more they make, and this gets more infinite as your account balance grows and your position size increases. To put it another way, they make far more over time from the good traders than they do from the bad ones. They also get the money from the bad ones anyway, as they over- leverage and over -trade.
Quite simply, it is in the broker’s best interest to stay away and let each trader go their own course; because ultimately, they will make money either way.
With that in mind; who is responsible, well the reason that stop hunting happens is because large funds such as hedge funds and large institutional traders have to find buy orders to match their sell orders and this is where they hunt your stops, so to speak.
To better understand this, we need to develop a deeper insight into how the larger institutions operate and how their operations affect our trading plans. The distinction here is purely down to trade size; so even though I was trading millions of dollars at the height of my fund trading career, I was still considered a ‘tiny fish’ in the same pool as the retail clients trading their own micro-accounts.
When looking for trading opportunities, the whole basis of our operation is to calculate which way the market might go next. More importantly, we need to time it stringently so that we enter the market in that direction as it starts taking off.
This is known as the ‘Perfect Trade’.
A large institution such as a bank, on the other hand, will significantly differ in the way that they trade. These are the players creating the moves and thus they have to time things completely differently.
Now, imagine that you are a large bank and that you have previously bought into the market and the market has now rallied so that you are in profit. The problem for you is that when you engage the market, you move it. This means that when you click ‘buy’, the price almost always goes up, until your order can be satisfied with enough sellers. This, of course, ends up giving you a worse price. This is called ‘slippage’, and is a big issue for large scale traders.
Another major issue is that of taking profits. Just like ‘slippage’, the same rules apply; if you just dump your position, the market is likely to revert against you (when closing a ‘buy’ order, you must sell it back to the market and that short, can push the price back down towards your entry point, wiping out some of the profits).
It’s a troubling problem as I’m sure you’ll agree.
So the question is; how do large players exit their positions whilst ensuring that they do not push the price against themselves?
The answer is, of course, ‘stop hunting’!
Here is an example:
The Large Player (LP) is long in position and wants to exit and take their profits.
The price is just below a level of strong resistance and the LP can see that there is likely to be a lot of traders placing Sell Orders at that level. In anticipation of the price moving down from that level, they can also see any orders that are placed on their books at these areas; providing further confirmation of pools of liquidity being present.