Stop hunting: a false pretext?

  • 2622
  • 0
We often read on trading forums that a lot of traders say that they have been victims of “stop hunting”. This often serves as an excuse for individuals to justify their losses. Are they right to complain or is that a false excuse?

Does stop hunting exist?



Stop hunting is practised by all banks. This is a practice that is normally prohibited since it is purely and simply market manipulation. But that remains difficult to prove and regulatory authorities cannot monitor all market transactions.

Stop hunting is possible because all professionals have access to the order book. They can therefore consult all buy and sell orders, and in particular stop loss orders. You should be aware that a stop loss order, once its limit is reached, turns into a market order. The order is then executed at the first available price for the quantity requested.

The purpose of stop hunting is to buy back liquidated orders at a lower price (so as to buy at the lowest price) or to sell liquidated orders at a higher price (so as to sell at the highest price).

Firstly, only very big market players have the ability to carry out this operation. Only institutional investors have the power to influence the market to the extent required. The operation needs to be carried out over a very short period of time so that the security’s trend and its market consensus are not brought into question. If the stop hunting operation takes too long it can trigger a massive buying or selling snowball effect from other institutions.

Let's take an example with a buyout. An institution sees a stop loss at €15 for 5,000 securities and wants to buy them at €14.50. The asset is currently quoted at €16. By looking at the order book, the institution realizes that between €15 and €16, there are not many purchase orders, say 2,000 securities. To go stop hunting at €15 and acquire the 5,000 shares, the institution places an order to sell 3,000 shares to clear the order book of all purchase orders between €15 and €16. So, when the price hits €15, the stop loss for the 5,000 securities is triggered. This order then becomes a market order. Meanwhile, the institution placed a buy order (larger than the one placed for sale) at €14.50 to buy back the stop loss orders and raise the price. Result, the stop loss at €15 for 5,000 securities completes with a sale of 5,000 securities at €14.50. The institution has bought these securities back at a good price and can then influence the price to return to €16. It bought the securities at the lowest price in a very short period of time and the asset can then resume its normal operation. The trader who had a stop loss at €15 sold at the lowest price, €14.50.

Of course I have simplified the process, but that's basically how it works. Without using the order book, institutions can also go stop hunting near areas of support/resistance or round figures.

The limits of stop hunting



There’s nothing more simple than stop hunting for a low value with low liquidity,. The order book is often thin and very legible. On the other hand, going stop hunting on a very liquid stock, like the EUR/USD or the CAC40, is more complicated and much more dangerous. The more liquid the product, the more resources are required. Not everyone can significantly alter the EUR/USD rate. Even for an institution it can be difficult to implement. Moreover, on liquid and highly monitored products, it is possible to trigger chain reactions more easily. If we resume our above example, by making the price fall to €14.50, it is very likely that this would trigger massive sales in its wake (irrationality of the actors, who are most often easily led).

To avoid any unpleasant surprises and make the task easier, institutions can join forces. There again, it is strictly prohibited, it is price manipulation, but there are enough scandals to show that this practice exists. It's always greed that gets people caught. To want to win too much by going to manipulate the course on very liquid assets, the potential of gain is certainly multiplied but the risks of being made take by the authorities of regulations also.... But it is not very serious for these institutions, it is better to pay a fine from time to time and make fat profits the rest of the time!

Can brokers hunt their client’s stops?



Between brokers, we can distinguish two main categories: the market makers and the no dealing desk.

The ‘no dealing desks’ only transmit orders to the market and offer their clients the liquidity offered by their various liquidity providers (banks and therefore market makers, etc.). It is these banks that manage their risk and market exposure since they (and not the broker) are the counterparties to your trades. The broker has no control over the quotations, he only publishes the prices he is given.

Market makers cover their own risk. They provide their customers with their own quotation. They are in control of the quotations they display to their clients. Market maker brokers are counterparties to their clients' trades.

With the market maker brokers, it is important to distinguish those who cover their risk exposure (who are simply counterparty to your trades but do not make money if you lose some) and those who play against the customer. A market maker is counterparty to your trades but has the choice of placing another order (in the direction of the client’s order this time) to be flat on the position. This risk management is carried out globally through a risk book.

For those who decide not to hedge their risk exposure and gamble against the client, the goal is to make their clients lose. The more customers that lose, the more they win. They therefore have every interest in hunting their clients' stop losses to maximize their profits. To do this, they simply spread out their spreads at certain times to get as many stop losses as possible.

But I'll stop you right there, I can already see you condemning market maker brokers. Only the smallest brokers play against the client and do not cover their risk exposure. This is also the case for unregulated brokers.

Those directly regulated by the AMF (I am not talking about the MiFID passport which is worth nothing - see MiFID regulated broker: a pledge of confidence?) are obliged to hedge against market risk and are therefore simple counterparties to the client (but do not earn money when the client loses). These brokers are generally those with a good financial solidity and therefore able to cover themselves on the market. That's why if you choose a market maker broker, you must make sure that it is regulated directly by the AMF and that it has significant capital and equity.

Don't confuse stop hunting with hunting your stop!



This is a very important nuance. There are no market maker brokers playing against the customer who directly chases your stop loss. All other brokers are there for you to make money. The more you earn, the more you process and therefore the more commissions you generate for them.

Everyone has been a victim of stop hunters at one time or other as institutions practice it all the time. These institutional investors (who are all market makers) are the ones who provide liquidity to the markets, and therefore create the market movements that come to trigger your stop losses.

But stop thinking you're the centre of the world! Institutions don't care about your stop losses! What interests them are large orders, those which represent millions of euros. No private individual reaches that position size and therefore you do not interest them with your orders of a few tens of thousands of euros at most. Your orders don't effect the market.

Don't confuse volatility with stop hunting



If your stop is triggered, it's because the market has decided not to agree with you, that's all. This is not a plot against you. Stop hunting between institutions is one of the elements that accentuates volatility on the financial markets. That's a certainty. But that's part of the game. For an individual, this stop hunting is therefore simple volatility that must be taken into account. You know that if you place your stop loss too close to a round number or a resistance or a support, you have high chances of seeing your stop loss triggered. Not because you are being watched, but because other investors (much bigger than you!) have placed their stop losses in the same place. So you can be indirect victims of stop hunting.
But it should not be assumed that stop hunting is practised continuously. When testing a resistance, a support or a key level, it is normal for buyers and sellers to confront each other. It is the law of supply and demand. Volatility also comes from this.

Other than that, if your stop loss is triggered, it's entirely your fault. You have to accept that and accept that you can lose trades. It's part of trading. There are no traders that only win. After all, your stop loss can be triggered for various reasons (stop loss too close, bad analysis or the market giving you wrong indications, etc.).

Conclusion



Unless you have chosen an unregulated or poorly regulated market maker broker, with low financial solidity, who plays against clients, nobody is going to hunt your stops. This does not mean that stop hunting does not exist, but it is practised between institutions. Your orders have no interest for them.
If you lose a trade, stop looking for someone to blame! Focus on yourself and your trading!

About author

  • 20
  • 42
  • 60
  • 5

Add a comment

no pic

Comments

0 Comments