Foreign Exchange Market "Stop Hunting" - What is it?

Foreign Exchange Market "Stop Hunting" - What is it?



You've probably seen it mentioned in various trading forums. It may have even happened to you several times. It's enough to make your head explode. What is it? It's called Stop Hunting.

Here's a typical commercial situation. You are convinced that the USD / JPY is moving up. You have entered into a long position in 123.40 and you set your stop at 123.05, slightly below obviously double bottom. You can set your initial target of 124.50, giving you more than a 03:01 ratio of reward to risk. Unfortunately, the trade starts going against you and break down through support. Your stop is hit and you're out of the trade. You're sure glad you had that station in place! Who knows how far you can reduce it's now broken that support, right?

OK. Guess what happens next. You got it ... after downloading from your stop price turns right back around and heads north, as originally thought it would. As you watch from the sidelines, the pair moves up past 124.00, then 125.00, and never look back. Just maddening. If you start thinking, "If only I put away a little lower. What lousy luck!" But is this really just a case of bad luck?

Let me relate one of my past trading experiences. Based on statistical trading tool that I use, I went short AUD / USD around 0.7530 and 0.7570 on the ends to which is above the local top. I was looking for a price to be reduced to less than 0.7300 over the next few weeks. In a day or so the price spiked, took from my stop, then move back into the consolidation area at around 0.7540. Now since the last jump, there were two local highs on the table near 0.7570. Not to be deterred from my trade, I re-entered my short position at 0.7530 area, and this time I put my stop at 0.7580, above the last spike. Anyway, what are the chances that the price will break through that resistance again? Well as it turned out, that's exactly what happened! The price spiked up and hit my stop again knocking me to trade a second time. And even more frustrating, as soon as my stop was hit, prices swung back again in the right direction I had originally anticipated!

Character of Ian Fleming, Goldfinger, once said: "After an accident, twice is coincidence, thrice is enemy action." (Plays James Bond music here ...) However, I was not actually paranoid enough to think that someone special just picking out my stop orders of course. First of all my trades were so small that no one would bother trying to take out a second I was doing these trades in a practice demo account! But I bet I was not the only dunderhead was making stops in that position obviously over the last highs. There are probably several Buy-stop orders in that price area, and it certainly looked to me like someone shooting for those stops. This hypothetical someone may stop the hunter.

So what is the end hunter and what is all this stuff about picking off stop orders? STOP Hunter is a market player that attempts to trigger the stop orders of other traders for their own benefit. They usually have the ability to move the market by a small extent for a short period. Hunter can stop dealing desk broker Forex trading which is in competition with their customers or may simply be a major player in the market, a bank, hedge fund or whatever.

Stop hunters operate best in an environment where most traders believe the market is about to move in a certain direction. As traders positions, inexperienced ones (like me in the trade above) will place their stops at obvious places to cut losses if the price moves in another direction. The guest hunters know where amateurs probably setting these stops, so they try to move the market enough to trigger. This can stop the hunter to enter the trade at a good price before the market begins its move in the direction that everyone expects.

For example, in my short trading above, there were many indications that the market was headed down. Stop hunters know that many traders had taken short positions, and probably positioned their Buy-stops to the 0.7570 area. So why stop these savvy hunters need to enter a short position at 0.7530 when so many were like amateurs willing to buy from them at 0.7570? So, they continued to push the price up to 0.7570, and when my buy-stop is activated, up there, guess who I am buying from? It ... stop hunters who sold me a great price (for them). Now I was out of the market, and they took my short position on Price 40 pips above where you entered. I had a 40 PIP loss, and they came at a price that is 40 pips better than they might otherwise have. Then, when the market headed down as we all expect, the guest hunters were laughing all the way to the bank while I was sitting on the sidelines pulling out what little hair left!

Keep in mind that the situation in which everyone expected the market to move up will only work in the opposite fashion. The amateurs will have sales stops at some obvious point below market, and the stop hunters will push the market down in order to trigger those sell-stop orders. Then the amateurs would be selling their long positions in panic, while the stop hunters were buying from them at great prices in anticipation of the coming move north.

Type of hunting guests that I just described is used in situations where most market participants expect prices to move in a certain direction. In this situation, stop and savvy hunters and amateur market have the same opinion, they do not fight each other in a contest of bulls vs. bears. The guest hunters are just trying to take over the position of amateurs at a good price.

There is another situation in which stop hunters try to move the market toward a group of stops in the hope that stops the trigger will push the market even in the same direction, causing even more stops and so on in a snowball effect. This is like some short-term panic and assemblies are created. In this case, the stop hunters have taken positions in the opposite direction from the amateurs, and simply trying to cause the stops to amateurs to panic and keep the ball rolling in that direction. My guess is that this tactic is more prevalent in less liquid markets like stocks and futures as opposed to FOREX.

In my next article, we will talk about how to set stops and better plan how to benefit from trade away hunters instead letting them eat lunch.

Scott Percival is the director of research for the Statistical Research Center Exchange Market-geeks.com, a site that is dedicated for the use of mathematics and the scientific method for studying the behavior of prices in the currency market. Mr. Percival has a degree in civil engineering from Northeastern University and has worked as a registered representative and trading instructor at Fidelity Investments. He is currently working toward the goal to become a full time Forex trader.


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