Stop loss hunting – how to defend yourself

I got a message this week from a trader: “could you tell us how to place our stops. I always get stopped out, I have tried tight and also fairly large stops …”

It’s a problem I expect that we’re all too familiar with – getting our stops hit.

I hate it when it happens to me … and I’m sure you do too.

So today I’d like to look at why we get stopped out … how to guard against getting stopped out … and when getting stopped out is okay … and how to make money from other people’s stops …

Does the mythical ‘stop loss hunter’ really exist?

The much maligned stop-loss hunter was the person employed by your broker (the only way they could know where your stops are). When the price got close to your stops, it was his job to momentarily widen the spread to hit your stop, before returning it to normal levels.

Does this job description really exist?

There are plenty of traders out there who’d swear blind that stop loss hunting has lost them hundreds of trades.

But I’m not one for conspiracy theories … especially when there’s a far simpler explanation …

Most of us put our stop losses in the most expected places – so there’s no insider knowledge required to pick them off. And the people hunting your stops are most likely to be large, institutional investors looking for the best, most liquid entry into the market.

So, yes, your stops are being hunted.

But is it an evil conspiracy against you by your broker? No.

And the good news is that there’s something we can do to protect ourselves.

What’s going on when your stops are hunted?

For big investors, with millions of pounds to worry about, getting into the market can be tough (my heart bleeds).

When these big players initiate a huge order, the price will immediately start to move against them as they create an imbalance in supply and demand.

For this reason, they want to find pools of liquidity to allow them to slip into the market relatively unnoticed.

And these ‘blind spots’ are created by the clusters of stop losses that us retail traders place around key levels.

We see it again and again – let’s say that the market is pushing up towards a key area of resistance. Our big player will enter orders to buy, pushing the price up through that resistance level.

Now, we mugs who put our stop losses just above the resistance level have just been stopped out … this pushes the price higher still, clearing more stops.

Now, is the moment our big player will sell – having created a nice pool of liquidity and exhausted the potential buyers at that level.

So, what can we do against these huge players?

We can’t hope to win against these market giants, but what we can do is to keep out of their way.

Think of key areas as magnets to prices – stop loss hunters will try to drive prices through these levels. We don’t want to put our stops too close to any of these areas:

– recent highs or lows
– round numbers
– popular moving averages
– Fibonacci levels
– Pivot points

This may involve trading with a wider stop that you’re used to using, but this needn’t mean taking on more risk.

Other ways to protect your trades

I’m not suggesting that you do away with stop losses altogether, but if you’re using a wider stop, it’s worth considering other ways to protect the money you have in the markets …

– exit criteria

Your exit criteria for a failed trade needn’t start and end with your stop getting hit. There are plenty of other ways that your trade setup could become invalid.

We often use our stop losses as the trigger for our trades being wrong, but there are other signs that you can close a trade, which may get you out faster and cleaner.

For example, would you close your trade if the market fails to move in a certain time limit? (This is a great way to get out of a momentum trade, where traders often use very tight stops.) Or if your technical setup is no longer valid? Or if some fundamental piece of news goes against our trade?

In this way, you could get out of a duff trade long before your stop is hit, which means less time in the market, and reduced risk on your trade.

– hedging

Using a hedge for your trade is another way to reduce risk without relying on a stop loss. Strategies like Martin Carter’s Diff Code Europe enable you to profit from a naturally hedged market, so you can still use a stop loss for protection, but it will be a wide stop because you already have a natural stability from your hedge.

Can’t beat them?

One of the tricks to succeeding as a small player in the market is to follow the big money. So, if you can’t beat the stop hunters – you can always try joining them.

If we know that key areas, surrounded by stop loss levels will be a magnet to prices, we can use our trades to play this momentum as the price moves through this key level.

For an example of this kind of trade, check out this Pivot Point Congestion trick.

This trick can be applied on any other key area where orders build up. I’d be interested to hear of any stop-loss hunting tricks you’ve had luck with …

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