“Stop Hunting”
Retail traders are generally aware of stop hunting, but have a wrong idea what it really is. It is not your retail broker slipping you for a few pips to get your stop. Those brokers do not have the size to move market in such a way!
As we covered in the previous article, large traders cannot simply accumulate or distribute a large position whenever they wish. They have to look for liquidity and stops are helping them in an indirect way, like I explained in the example above. That is why stop hunts tend to be quickly faded: The large bids or offers got filled and with the stops triggered, there are no buyers left in a buy stop-hunt scenario and no sellers in a sell stop-hunt scenario. Those bids and offers tend to stabilize the market. If there were little of them availaible as the stops get triggered, it would result into an event called a stop cascade — there is insufficient liquidity for the stop loss orders and price gets pushed into the next area of large stops until bids/offers in good size appear.
There are also traders that anticipate such moves and look to take profit near the level where stops are rumored to be. Those are mostly short-term speculators and model funds (which buy/sell on momentum). They will take advantage of the forced buyers/sellers and liquididate their position as price hits into the stops. We will cover the topic of how to identify levels of concentrated stop loss orders later.
Dealers also participate in this activity. While there are looking to make some profit from short-term trading, their main task is to provide clients with liquidity and get them filled with less as possible slippage. Let’s go through a scenario:
EUR/USD is trading at 1.3050 and Dealer “A” sees many of his clients have buy stop orders from 1.3100 up to 1.3110. This means those clients want to get out of their position once price breaks above the determined rate. If he does nothing and waits for price to break above 1.31, he will have trouble filling his clients without slippage. There will be stops from other market participants above 1.31 and other dealers will be acting similar, pushing price higher fast. He would fill his clients at a bad rate, earn nothing from it and his reputation would be seriously hit if this would happen several times.
So what can he do? He can gradually start to accumulate a long position and anticipate a break of 1.31 into the stops. Dealers tend to have a great feeling for short-term moves and are skilled for having “a feel for the market”. If he gradually buys EUR/USD all the way up to 1.31, he will be able to fill his clients without slippage and will make a nice profit from it.
More detailed example:
DEALERS ORDER BOOK:
Buy Stops from 1.3100–1.3110 worth $100 million
DEALERS ACTION:
Buy 20 million @ 1.3060
Buy 20 million @ 1.3075
Buy 20 million @ 1.3080
Buy 20 million @ 1.3085
Buy 20 million @ 1.3090
Net position = Long 100 milion @ 1.3079
So he will distribute his position as price breaks above 1.31 and fill his customers stop loss orders.
This can of course go wrong if price fails to maintain the upside momentum and turns lower. The dealer must then quickly get out of his position. But again, those traders are skilled at managing their positions and while they can’t be right all the time, like other traders cannot too, they have a good feel for the short-term moves.
