Do you ever have the feeling someone is out to get you when you trade? You were just taken out of a trade after it spiked, which then turned around and made a sharp reversal.
Someone is out to get you. Guess who?
You may think your Forex broker is hunting your stop losses, simply because they can see them all and they may be a market maker. The truth is your Forex broker wants successful traders. They make commission based income on the spread price, so if a trader burns an account after just a few trades, the broker won’t receive commission anymore.
The true stop loss hunters are large institutions and hedge funds. As we saw in the currency pairs guide, when trading, there needs to be a buyer and a seller. If the hedge fund is in profit and they are looking to close out a position, they will need to close their position with smaller trades. The market makers will help find the buyers or sellers. For each trade, the price is slightly affected, meaning the hedge fund can’t sell all of their position at the same price - or they risk getting filled at bad prices.
If the institutional trader can see a key area where they believe many stop losses may be hiding, with high confluence, they may try to push the price through the barrier so it takes out the stops. This may provide them with the liquidity they need to close out their entire position.
Stop Loss Hunting Example
- Institutional Trader: Buys currency at 1.000 and their goal is to sell at 1.1000 (Long position).
- Home Traders: As the currency reaches 1.0950 they sell and place a stop loss. behind the round number at 1.1050 (Short position).
- Institutional Trader: Makes calculated risk on whether to push the price up.
- Institutional Trader: Buys another large position to push the price through 1.1000 and ends up at 1.1200.
- Home Traders: Many are closed out because their stop losses were triggered, which pushes the price even higher.
- Institutional Trader: Sells all their position with a good average selling price.
Many learn-how-to-trade examples tell you to always put on stop losses, to prevent yourself from allowing losses to go too far. This is somewhat true. However, if you train your mindset to always be objective about the price, you can adapt your position as the prices change, so long as you have solid reasoning.
The EURCHF crash of 2015 and the more recent algorithmic GBPUSD price spike in 2016 showed how stop losses don’t always work as expected and can never be guaranteed.
Stop Loss Trading
Hunting for stop losses is a valid trading method in the financial industry. It’s an art to flush out losing traders and pick off the unnerving ones. Unfortunately, it’s not possible to move the market so much, unless you’re trading in hundreds of millions of dollars.
You could however manage your risk by only placing a small portion of your account size on the initial trade and increasing your position as the price spikes through, if you believe the position is being stop loss hunted. This will also change your average position price.
For now, it’s best to be aware and just think about the other players who could be out to get you.
- Forex brokers and market makers are not stop loss hunt
- Stop loss trading is a valid strategy.
- To reduce your risk, split your available position size across two entry prices.