A common challenge for retail forex traders is determining where to place their stop losses. There are predictable patterns in the behaviour of retail traders that institutional traders can recognise and often benefit from.
Institutional vs. Retail Traders
Institutional traders trade on behalf of groups or institutions they oversee, whereas retail traders trade for personal accounts. Institutional traders typically deal in larger quantities and trade more specialised financial products. Institutional traders include banks, hedge funds, and investment firms.
Institutional traders often aim to hit the stops and close the trades of retail traders to free up liquidity – known as stop hunting.
This practice is controversial among retail traders who feel targeted by big institutions. These institutions are looking for areas where many traders have placed stop-loss orders at predictable price points.
Because some view stop hunting as manipulative, it could be perceived as unethical.
Stop Hunting Strategy / Image by Tima Miroshnichenko from Pexels
What is Stop Hunting?
Stop hunting is a strategy used by experienced traders, particularly large institutions, to take advantage of stop-loss orders placed by other traders. A stop-loss order is an instruction given by a trader to their broker to close their position at a specific price level to minimise losses.
Institutional traders who use a stop hunting strategy identify areas where many stop-loss orders are clustered, typically around predictable price points such as support or resistance levels. Support and resistance levels are points on a chart where the price has historically bounced back, making them likely places for traders to set stop-loss orders. Due to the large volume of assets traded by institutional investors, it can be challenging to find enough willing buyers or sellers at the current price.
By temporarily pushing the price in that direction (through buying or selling a large volume), they can set off a chain reaction. If their intuition is right, a cascade of stop-loss orders will be triggered, automatically selling assets, and potentially driving the price further in their desired direction. This presents an opportunity for the stop-hunter to profit by buying back the asset at a lower price (if they were pushing the price down) or selling at a higher price (if they were pushing the price up).
An effective forex stop hunting strategy requires two things:
- Identifying clear technical levels that retail traders commonly use to conceal their stop-loss orders.
- Entering a position that seeks to capitalise on these stop-loss orders.
It is worth noting that the predicted price movement may not occur, leading to potential losses for the stop-hunter.
In Conclusion
Stop hunting is a complex strategy that involves risks. However, traders can protect themselves and benefit from this tactic by understanding how it works and knowing how to place well-managed stop-loss orders.
Retail traders may find this strategy frustrating, but it is a common aspect of the forex trading environment. Potential losses can be minimised by awareness of this strategy and proper stop-loss placement.
Stop hunting adds a layer of complexity to forex trading. However, it can be a profitable technique for those who use it effectively.
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