Stop loss hunting happens every day and most traders are not aware of how this exactly works. Most liquidity providers and some brokers use software to hunt stops and this is a very lucrative business scheme. Since brokers promote using a stop loss, they know exactly where you want to take a profit or a loss . In this article I will describe how and when stop loss hunting occurs and how to deal with it.
First you need to understand the difference between stop loss hunting and market manipulation. They are often mixed up. Price manipulation as we know it, is done by institutions and not by brokers.
For example; If a hedgefund wants to buy EUR against the dollar, they try to buy them at the best possible price. The lower the price the better it is. Their dealers will calculate what it will cost to lower the price with 50 pips. If they want to do a 5Bn trade, it’s a good bargain to drop the price with only 500Mio. Since they can see the bids and asks they know when to enter the market and let their algos do the lower bidding. This part is hated by all retail traders desperately clinging to their stop loss orders. Now the price will start to spike down after after which it will spike up and will most likely continue to go up.
This so called “buy or sell zone” is what many daytraders use to their advantage. Some indicators can be useful to spot these buying or selling zones. Unfortunately one will never be sure if the spike is indeed due to manipulation or if it is a whale going short.
Market manipulation, though toxic, is something all traders need to deal with. Stop loss hunting on the other hand is a malicious practice done by dodgy brokers / liquidity providers to turn your trades into losses.
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How many times were you looking at a trade that got stopped out after which the market went back into green territory. But.. your stop was already hit. So bloody annoying!
Since the cfd market are not traded through an exchange you will always depend of the price feed provided by your liquidity prover / broker. The most common practice to hunt your stop loss is by simply widening the spread.
Look at the chart below and notice the spike below the red arrow. As you can see, 2 contracts long Gold were stopped out.
The spike did clearly NOT hit the stop loss level. However, the broker stated that this happened due to the “Asking Price” at market opening. The spike only shows the “Bid Price” and not the “Ask Price”. Basically this means that brokers or LPs can give any price feed at their convenience. Don’t forget, they can SEE where your stops are placed!
The most popular timing for this procedure would be at or just after market close or at market opening (Sunday night). This is one of the main reasons to use an ECN account where you can at least check the bid and the ask price. Choose your forex broker wisely!
Although it typically happens at or after market close or at market opening stop loss hunting can still very well occur during the day. Liquidity providers as well as brokers use software to make the job effortless. Every time your stop loss is near the current price, they simply widen the spread.
It’s very hard to detect stop loss hunting. Since brokers don’t do it constantly, but only when it pays off. For example, a big level is a nice spot to take free money. EURUSD breaks 1.1300 on the way down, thats where many stops will be located.
I usually video tape the tick chart and try to spot fast moving prices where I have another platform from a different broker open as well. If I detect a difference I report this with my broker. It might happen some brokers repay you some money avoiding bad publicity. Bottom line: if you see it happening, switch your brokers asap!
You can never really avoid this from happening. Liquidity providers have much better tools to play around with.
What is important is how to use a stop loss and where to place it. Also, consider to always close your position at least one hour before market close.
How to place your stop loss to avoid stop hunting
Let assume you trade Gold. If you are long at $1805 and your stop loss is placed at $1800, you can be sure that your stop will be hit overnight. A $5 widening of the spread at market opening is nothing for an LP. Therefore better put your stop much lower around $1790. If this means your risk reward ratio is bad, then.. don’t make the trade at all.
Another option is to use a forex robot that hides your stop loss and take profit levels. Its a very useful trading tool In case you are interested in this software, feel free to contact us.
Every week we start with new algorithmic trading strategies that you can copy in a demo account.
Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 74-89% of retail investor accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.