We have all heard about stop-loss hunting. It happens with stocks, forex and other trading instruments.
What does it look like?
Good, good… but what the hell does that actually mean?! Well, let me show you a chart for a clearer view:
In the EURUSD 1H chart above we have a clear downtrend. Moreover, there’s a rather obvious down-trendline that probably most traders have drawn on their respective charts. Alright, in this scenario, where are most traders to place their stoplosses? well, probably few pips above that trendline, isn’t it?
Big dogs (institutional traders, investment banks, hedge-fund managers and the sort) know this. They can “smell” where retail traders (us) have placed our stoploss orders, and they more obvious the trendline or the support/resistance level the better for them. Since those guys have the muscle to spike price under some specific conditions they mercilessly raid our stoplosses in order to shake us out of our positions.
How do they do it? well, they usually wait for volume dryouts in the market so they can indeed move the market with their massive orders. News announcements are their favorite time due to the high volatility market conditions. This is exactly what happens:
1) They wait for price to reach that hot level (in the previous example, that’d be the trendline near-abouts).
2) Then when trading volume is thin in the market (right at the news announcement, or during an off-peak time of the day, etc), they slap their massive orders into the market just enough to drive price beyond that key level.
3) All those poor people’s stop losses get triggered!
4) And here is the beef of it all: a stop loss order is nothing but a pending order opposite to your current position. In the previous example, since we were in a downtrend, most of the people who were short EURUSD also had a pending buy stop order (meaning their stoploss order) few pips above that trendline. Are you with me so far? so effectively what we have is a bunch of buy stop orders triggering at once, which actually enhances and accelerates the breakout thrust even further!
5) At this time, we have many people (AKA stoploss orders) wanting to buy EURUSD. And if someone buys EURUSD, that means that there must be someone else SELLING -shorting- EURUSD to them… Guess who is shorting EURUSD off those stoplosses? BINGO! the Big Dogs are feeding their positions off those stoploss orders because they know that the breakout is in fact only a fake breakout (since they popped it out of the blue at the end of the day) and soon the downtrend will resume as expected. So what they are effectively doing is re-loading short in a downtrend by forcing those buy stop orders to trigger. Evil, isn’t it?
Please note how the stoploss run (both to the upside and to the downside) happened very quickly, within one or two bars and usually with long-wicked bars. The breakout-thrust happens very quickly because, like I said before, all those stoploss orders triggering in cascade accelerate the move. And once all those stoplosses have been dried-out, price falls back down just as quickly!
That is why it’s very dangerous to trade through news announcements if we are near a significant level of support/resistance – you never know, there might be some Big Dog out there ready to breach through that level of support/resistance hoping to raid some -YOUR- stop loss orders.