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Do Forex Brokers Really Stop-Hunt?

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Have you ever set a stop-loss, only for price to hit your stop and blast off in the direction you anticipated? You may have been stop-hunted.

While many traders believe it's their broker hunting their stop-loss, the actual answer is more complex. In this article, we'll explain who's really hunting your stop, show what a stop-hunt looks like on a chart, and offer some tips on reducing your chances of becoming the victim of a stop-loss hunt.

What is stop-hunting?

The Forex market is the world's largest financial market. With trillions of dollars flowing through the market every day, it's rare for a currency pair to jump more than a couple of percent in a day. As a result, leverage is almost always necessary.

Leverage in the foreign exchange market varies from country to country, but it generally ranges from 20:1 up to 500:1. This means that using a stop-loss is essential to avoid margin calls and stay in the game. After all, stop-losses are one of the best risk management tools available to a trader.

Now, imagine you were a large financial institution looking to take a $1 billion long position. Chances are, there aren't enough sell orders on the books to fill your buy order at your preferred price. If you were to press "Market Buy," the lack of liquidity would lead to slippage and put your average entry price much higher than you'd like. For our $1 billion position, this might mean losing a few million to slippage.

The problem is, where do you find the liquidity to get your order filled? Where will there be at least $1 billion in sell orders? In zones where stop-losses are placed. Retail traders and less savvy institutions often put their stops below a key support level, trendline, or round number. Who else is getting involved at these levels? Breakout traders.

As a financial institution with plenty of resources at our disposal, we can sell heavily into one of these zones, triggering long stop-losses (i.e., selling back their buy position) and encouraging short breakout traders to jump in. Meanwhile, we use this flood of sell orders to fill our $1 billion long order with minimal slippage.

As the price begins to rise, emotional traders that were stopped out and short traders now at a loss capitulate and start buying. This gives us the liquidity to exit our short position that began the stop-loss hunting in the first place. The net result is that we've entered our position with minimal loss (maybe some fees/slight slippage vs. significant slippage) and stoked the emotions of other traders that are now looking to reenter their position and push the price higher - putting us in profit.

While this may sound cruel and unnecessary, it's a fundamental characteristic of many markets. In fact, it's a practice that dates back decades. In the 1930s, Richard D. Wyckoff noticed that retail stock traders were constantly being manipulated by large institutions or the "smart money." He simplified the concept using the idea of the "Composite Man": a person who, "in theory, sits behind the scenes and manipulates the stocks to your disadvantage if you do not understand the game as he plays it; and to your great profit if you do understand it."

Stop-loss hunting occurs everywhere, from the second charts to the monthly charts. One of the tell-tale signs is a long wick that reaches into an area where stops are likely to be: above or below double tops and bottoms, in an area of support or resistance, around trendlines, etc.

Do Forex brokers hunt stops?

The common perspective of many retail traders is that Forex brokers regularly engage in stop-loss hunting. Unfortunately, this is more of an excuse for poor trading practices than anything else. True, some dodgy brokers may engage in stop-loss hunting, but if your broker is regulated, chances are, they're not performing as a broker-hunter.

There are anecdotal reports of traders seeing their stop-loss triggered despite price not actually hitting their stop, but the reality is that it's bad for business. A broker primarily makes money from spreads and commissions. It's in their interest for you to keep trading with them. If they continually hunted your stop-loss, then you'd probably go elsewhere.

Some traders will think they've been stopped out prematurely when it was actually a widening spread that got them stopped out. This is especially likely if they were stopped out around a significant news event or late in the trading day.

But what about market makers? Can market makers see stop-loss orders? The short answer is no. The long answer is maybe, but only if your broker colluded with a market maker. The issue lies in the nature of a stop order. A stop is essentially an instruction that says, "once price crosses x, do y." A stop-loss is an instruction for your broker to create a market order as soon as price reaches a certain point.

Market makers only have access to order books containing pending limit orders. A stop-limit order, for example, wouldn't be visible to a market maker; only after the stop is triggered and the limit order becomes active would the market maker see the order. So, your broker is the only party that can see your stop-loss order. A broker could provide a market maker with access to stop orders, but this would be highly unethical and likely illegal in many jurisdictions.

If you're concerned that your broker is engaging in stop-loss hunting, then trade with an ECN broker. ECN brokers connect traders directly with liquidity providers and are unable to trade against you.

The real stop-hunters

As you might have guessed by now, the players that stop-loss hunt are big banks, financial institutions, and hedge funds. These are the big guys that make serious money from trading the Forex market each year and have the resources available to manipulate such a big market.

While one might conjure up images of suit-and-tie executives sitting around a table in downtown Manhattan, plotting how they'll take out your stop-loss, it's a much more dynamic, decentralized, and complex process. On the one hand, there are algorithms and high-frequency trading desks that specialize in identifying and trading areas of liquidity across every time frame in nearly every market. On the other, there are manual prop traders that understand how stop-loss hunting works and use it to their advantage.

The culmination of these efforts is what we see on the charts: a long wick, often just beyond a key swing high or low, before blasting off in the other direction. Let's take a look at a quick example before moving on to how to avoid being a victim of a stop-loss hunt.

EUR/USD example

Here, we can see some obvious manipulation of liquidity. Multiple lows are formed before two long wicks take out the lows, leading to a move much higher.

The support level forms and then two spikes take all the liquidity of it out.

Switching down from the 15-minute to the 2-minute timeframe, we can see how liquidity is forming. The first is with the trendline. It gets broken (1), and traders are stopped out while breakout traders enter short (especially after the retest of the trendline - a classic breakout confirmation move). Price quickly reverses before wicking above the opposing liquidity (2) and moving back down.

Liquidity is drained by a false breakout.

Price retraces (3), just taking out the liquidity above the previous swing high. It then tumbles below where many traders would consider support (4), triggering tons of stop-losses.

The price bounces down from a resistance but breaks through the support to get all the liquidity there.

Looking at the stop-hunt on the 1-minute chart, we see the same thing happening. Liquidity builds up in the form of relatively equal lows before taking them and the swing low out (5). The final stop-loss hunt has occurred, the big players are in their positions, and they're ready to take price much higher.

The situation is the same on the long-term charts as the liquidity is taken out from beyond the support and resistance levels.

How to avoid being stop-hunted

So, we know how stop-loss hunting works, why it occurs, and how it looks on a chart. But how do you avoid being stop-hunted yourself? Here are some crucial rules to follow.

Avoid placing stops at obvious levels

More often than not, areas prime for stop-loss hunting are visible on the chart. They're typically in one of the areas discussed: above or below key swing highs, support and resistance levels, trendlines, etc.

As a rule of thumb, the more an area seems to "hold," the more likely it is to be stop-hunted. Each time the area is tested, more traders funnel into positions and set stop-losses just above or below the area. This is precisely what smart money is looking for to fill their orders.

Instead, you could use a wider stop, avoid round numbers like 1.27 or 1.275, or place your stop in an area that clearly invalidates your idea. Alternatively, look for confirmation before entering.

Look for confirmation

One of the easiest ways to avoid being a victim of stop-loss hunting is to look for confirmation. Instead of blindly leaving a limit order and stop-loss at an area of support or resistance, you can look for price to trade into it and then show signs of reversal. This could be through reversal candlestick patterns, like tweezer tops/bottoms, hammers/shooting stars, and engulfing candles.

Like in the example above, you could also look for stop-hunts on lower time frames. For instance, if you're bullish from a 1-hour area of support, you might look for stop-hunts on a 15-minute or 5-minute chart to confirm your bias and find an entry.

Use retail trading patterns with caution

On the topic of patterns, use chart patterns with care. Triangles, wedges, double tops/bottoms, pennants, etc., are all prime candidates for smart money manipulation. This is because the big players know chart patterns are where retail traders like to get involved.

That's not to say that chart patterns don't work - they do, but their reliability is overstated. For example, you'll often see the upper trendline of a bearish wedge being breached before the move lower occurs as part of a stop-hunt. How do you get around this? Again, look for confirmation or wait for the stop-hunt to occur before entering.

Don't set stops too tight

One of the easiest ways to get stopped out prematurely is by having a tight stop-loss. Tight stop-losses work well in some strategies, but the average retail trader will likely fare much better with a wider stop. The returns from a given trade might be lower, but the goal as a trader is to consistently generate profit over securing huge wins every time. Widening your stop to a point where your idea would become invalid is a strong place to start.

Add the spread to your stop

Finally, add the spread to your stop. As mentioned earlier, many traders think their broker is stop-loss hunting when it's more likely that a wide spread got them stopped out. During periods of high volatility or low volume, note the spread and set your stop-loss as usual. Then, add (or subtract, if going long) the spread.

For example, let's say you're going long EUR/USD with an entry at 1.05850 and a stop-loss at 1.05785. If the spread is 3 pips, you'd subtract 3 pips from 1.05785 to get 1.05755. This is where you'd set your stop-loss.

Final thoughts

In summary, your broker most likely isn't hunting your stop-loss. If they're regulated and trusted by other traders, then chances are you're good. If you deal with a shady broker and you think they might be stop-loss hunting, there are plenty of better brokers out there that don't stop-loss hunt. Even better, choose an ECN broker to remove the possibility entirely.

Stop-hunting is the domain of financial institutions with lots of money at stake. It dates back long before many of us were even born and will continue to be a feature of virtually every market for decades to come.

While there are ways to counteract stop-loss hunting, it's best to trade in harmony with these big players rather than fight them. If you want to learn more about using stop-hunts to your advantage, check out the Wyckoff methodology. The whole notion of Wyckoff accumulations/distributions is based on stop-loss hunting and could be an excellent addition to your strategy. Happy trading!