i. Traders claim that the broker and the market are conspiring against them by hunting stop loss.
ii. Liquidity grab is what actually happens in the market.
iii. No point blaming the market for failing to place stop loss properly.
Many traders say that the markets and the brokers hunt the stop losses of retail traders and take away their money. This is not exactly what happens but rather these are mistakes done by the retail traders and things can be done differently to avoid this.
What is a stop loss?
A stop loss is basically an order that a trader places in advance after they enter trades, with their broker instructing them to exit the trade once the last traded price of the currency has reached that specific price level.
The stop loss is an order to limit a trader’s loss on a particular position by limiting the downside or upside risk that the trade might be subject to.
The stop loss order could either buy the currency when it reaches the pre-determined price level or could sell the currency when it reaches the pre-determined price level.
For example, a trader wants to enter a long position on the USDINR currency pair, the trader is of the bias that once the USDINR pair breaches the 73.5000 price level, the price would go all the way to 74.0000.
With this, the trader has his upside pre-determined, but since this is a naked position and not a hedged one, the trade position has unlimited downside risk i.e. the price could fall hence invalidating the trader’s bias.
In order to limit the downside risk of the trade position, the trader would enter a stop loss order, at a price point that would allow him to profit out of the upside movement of the currency price and also limit his risk in case the currency’s price declines.
What is stop loss hunting?
Traders have often experienced that once they enter trades, the price first goes all the way to their stop loss price level, triggering the stop loss order, and then the price goes on to their target price level.
It is indeed frustrating to see that the analysis one performed was right but they couldn’t capitalize and earn a profit out of it but instead they had to incur a loss on the position that could have been the opposite. Traders often call this stop loss hunting.
They define this as a strategy that the brokers utilize in order to force traders out of their trade position by driving the price of the currency all the way to the price level that traders would have set as their stop loss, allowing the brokers to earn their full commission at the cost of their clients incurring a loss.
Stop loss hunting - Truth or myth?
It certainly is disappointing to see that unfair means are being used against the smaller traders by the big traders, if this phenomenon of stop loss hunting was true.
But the reality differs. Stop loss hunting is just a term made up by small unsuccessful traders in order to justify their shortcomings by blaming their loss on someone else.
For many traders taking a loss is not just a blow to their trading capital but also a blow to their ego. They just cannot bear with the fact that they were wrong with their trade plan which made them incur a loss.
Hence, they go on to blame the market and their broker for the loss that they had to incur, hiding their insecurity of being wrong.
The truth of stop loss hunting
Let us consider for an instance that the allegations made against the brokers were true, that they did indulge in this practice of stop loss hunting, but what do they stand to gain?
It is important to note that in order to become a certified and regulated broker, a company has to take membership at the exchange which requires them to undergo lots of compliances as well as pay a huge sum of money at the exchange.
The company then goes under scrutiny before they are granted a license to become a certified broker.
It now brings us to the question of whether a company or a broker would resort to an unfair practice of stop loss hunting in order to make some quick money at the cost of their broker license, the sum of money that has been deposited with the exchange, their reputation.
The risk that is involved for the brokers in this is way more than what they stand to profit from.
The blame game
Wouldn’t the world be a better place if people admitted that they were at fault rather than blaming their shortcomings on others?
By blaming the brokers for triggering their stop losses, the traders indulge in nothing but a blame game.
Instead of this, if the traders actually reflected upon their trading plan and tried to figure out where exactly their analysis had gone wrong, they would have already been successful in this world of trading.
This is exactly what separates good traders from bad ones. If the traders actually reflected upon this, they would notice that their trading plan was on the right path it was just that their risk management was lacking which cost them the trade.
What to do?
In scenarios of stop loss hunting, it is always seen that the traders place their stop loss at the wrong price level.
The stop loss is to be placed at such price levels that would make it crystal clear to the traders that their analysis was invalidated and that they were wrong in their trade plan.
For example, if a trader entered a long position in the EURUSD currency pair, the entry price being 1.2000.
After performing the analysis, the trader sees that the price might decline maximum to 1.1750, in this case, if the trader places his Stop Loss at 1.1750, then the trader would be Stopped Out once the price declines to that particular price point.
The better practice here would be to place the Stop Loss at 1.1740, which is below the expected price decline.
This would ensure the trader that he would still be in the trade even if the price had a big decline but not enough to breach the Stop Loss price level.
Placing stop loss - The better way
Traders often fail to place their stop losses at the right price points because they trade based on support and resistance, trendlines, or patterns.
These methods are widely used by traders all around the world but only some are able to utilize this in the right manner.
I. Support and resistance
1. Basics of support and resistance
Support and resistance are price levels or zones on a price chart of a currency from which the price is repeatedly bouncing away.
Support is a point at which price arrives and then rises from. Resistance is a point at which price arrives and then declines.
These points of support and resistance are determined by moving to the left-hand side of the price chart of a currency in order to have the historical price movements on the chart.
2. Support and resistance - Zones are the key
Traders may enter a long position when the price arrives at support or may enter into a short position when the price arrives at a resistance.
The mistake that the traders commit here is that they identify the price levels and not price zones.
For example, a trader looks at the price chart of the GBPUSD currency pair, they may identify that there is a support at the price level of 1.3000, they immediately mark this as the support level.
They would get into a long position once the price arrives close to the support and place a stop loss just below the support level they have identified maybe at 1.2750.
But then they would get stopped out as price declines a bit below the support level of 1.3000 and goes on to hit their stop loss and removes them from the trade with a loss incurred.
In order to avoid this from happening, the traders could mark a price zone from 1.3000 to 1.2750 as a support zone.
They could enter into a long position once the price reaches this zone and could place the stop loss just below the zone or a few pips below the zone.
This would allow them to stay in the trade if there is some short impulsive movement in price which then moves in the direction of their trade bias.
3. Ignore the noise and focus on quality
Another mistake that traders commit when they trade based on support and resistance is that they would identify any random price point from which the price bounced at least twice.
It is important for traders to separate noise on the chart from actual substantial information.
There could be innumerable price points on the chart at which prices bounce from, but traders have to enter into positions only at those levels which are created by a good price rally and not a short price movement.
Identifying the quality of support and resistance levels or zones is all learned from experience.
1. Basics of trendlines
Trendlines could also be seen as a support or as resistance but the difference here is that it isn’t a horizontal zone but instead it could either be an inclining or a declining line that it drawn connecting the recent lows or highs of a price.
Traders often use this method to trade breakouts that the price might experience.
In order to identify a trendline, traders have to look for two recent lows or highs made by the price and connect them with a line drawn.
2. Trading the trendline
Traders use two methods to trade trendlines. First, they would enter a short or a long position at the first instance of the trendline being invalidated, or, second, they would look for the trendline to be invalidated and then wait for the price to have a pullback towards the previously invalidated trendline and the bounce away from it.
The first method is a comparatively more aggressive type of entry and the second is a conservative type of entry that looks for double confirmation.
Traders can look to incorporate any of these methods that would suit their personality and their trading plan.
3. Protect the stop loss
Stop loss can make or break a trade. Traders should place their stop loss above or below the recent high or low made by the price in direction of the slope of the trendline.
For example, a trader identifies an upward sloping trendline on the price chart of the GBPUSD currency pair.
The price then breaches the trendline and gives a trade opportunity to the trader. The trader could choose to enter right away or could wait for a pullback.
The stop loss in this trade would be placed just above the highest price point that the currency had reached before it breached and invalidated a trendline.
It is often seen that once the price has moved to a certain price point, it can always arrive at it again.
So taking this into consideration, stop losses should be placed either above or below such highs or lows made by the price before it invalidates a trendline.
Traders can then capitalize on breakouts ensuring that their stop loss will not be triggered and can profit from the price rally that often takes place after a breakout.
1. Basics of patterns
There are several chart patterns that have been identified by traders that give them an idea of the direction in which the price would move in the coming trading sessions.
Traders utilize these patterns and then enter into positions based on the type of these patterns.
These patterns could either be reversal patterns or continuation patterns.
2. Trading the patterns
It is important to note that these patterns are not always to be traded standalone i.e. trade decisions are not always to be taken solely based on what pattern has been formed on the chart.
These patterns combined with the support and resistance zones could give a good edge to the traders and could allow them to take quality trades and profit handsomely from them.
In order to profit from these patterns, it again comes down to the proper placement of the stop loss.
It is observed that these patterns are formed near an already existing support or resistance zone.
So the most prudent practice would be to place the stop loss above the resistance zone in case traders are to enter in a short position or would be placed below the support zone in case the traders are to enter in a long position.
This gives traders double confirmation and increases the probabilities of their trade being successful and allows them to make profits.
Do you also believe in stop loss hunting?
Are you also one of those that believe that the brokers and the markets are conspiring against the retail traders to take away their money? I hope you aren’t.
Don’t you also acknowledge that if traders started placing their stop loss better, their trading results will improve drastically?
Share this blog post with others and let them also know the truth of stop loss hunting and the right ways to place stop loss while trading different strategies.
As always, feel free to reach out to me through the comments section for absolutely anything and I will get back to you at the earliest.