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Are Stop Hunts A Real Occurrence?

by on May 31, 2014 5:24 am BST
 

Have you ever seen a move on a position that seemed to come out of nowhere? Likely, the move was just enough to take out your stop-loss order and kick you out of the trade. It, then, seemingly reverts back to its original directional movement. You then ask yourself “did the market just single my stop-loss out?” The answer is yes. Hunts for stop-losses happen often, almost daily, and this is why:

The foreign exchange market is a dealer market rather than an exchange market, as seen in equities. Dealers are not just meeting buy orders with sell orders like on an exchange. They often act as counter-parties and take the opposite side of the trade – a clear conflict of interest. This is typically seen in a dealing desk broker. However, retail traders have sought out to seek non-dealing desk brokerages and switch to a brokerage that has an electronic communication network (ECN) account. This is where the broker routes the order to the larger interbank network that is directly hooked into bank liquidity. Nevertheless, larger dealers are more willing to take on the risk to counter the trade.

Stop hunts are generally seen around key price points, such as support and resistance or round numbers. Brokers know that stops are generally clustered around these areas, so they will actively spend their own capital to seek out these areas of interest for the sole purpose of knocking orders out of the market. For instance, a trader enters a sell order of 100,000, or one lot, on AUDUSD. The pair is currently trading at .9267, and it is likely the trader would place their stop at .9300 or near it, such at .9310. Instead of selling the position in chunks through the market, the dealer will decide to take on the own position since they already know their clients’ stop-losses.

Stop hunts are not always profitable for the broker because price action can change instantaneously; but, given the vast resources (technology, information, and capital), large traders will always attempt to collect the stop-loss orders.