Stop Loss Hunting
Often in a range-bound market – where traders seek direction, because of a lack of fundamental news flow, or a lack of market sentiment – we see price action which tends to drift in either direction and in small increments. That is to say, the size of the candlesticks are small, usually no more than 10-15 pips. Sometimes these types of trends present opportunities to traders who are looking to take advantage of triggering stop losses.
Professional traders, and in particular institutional size traders, who trade in large lot sizes, and who have the most to lose if the trade goes against them, tend to put their stop losses a couple of pips underneath the lowest point of the preceding candlestick when they buy a currency pair, or a couple of pips above the previous high of a candlestick if they intend to go short. Tight stops such as these minimize losses for traders who trade in large amounts.
And because professional and institutional traders tend to trade the same way overall, they know where stop losses are placed. It is important to add that professional and institutional size traders tend to use the 15 minute, 30 minute, and higher time frames for their technical analysis. This presents opportunities for all traders, including retail traders, to keep their eye out for stop-loss hunters.
Example A
Let’s take a look at example A, to see how this might play out in a real scenario. This is a fairly typical price action chart that you will see almost every day in the forex market. On the left-hand side of the screen, we can see eight small bull candlesticks of around 5 to 10 pips in size with small or no wicks, and where price action tends to just almost drift higher. Because the candlesticks are small in size, it means we have a series of 8 fairly closely situated stop losses, and we know that these stop losses are likely to be institutional size, because they are on a larger time frame, including or above 15 minutes.
Candlestick A, is a bearish reversal pattern, followed by an engulfing bear candle that will have triggered three stops in this example. The warning is pretty much written on the wall for other long traders who bought the upward move, and some will begin closing out trades while the rest are in danger of being stopped out.
When stop losses are triggered under these circumstances, they can create a void, and especially in a pair where there is a lack of overall bias, fundamental reasons, or sentiment, and this void may see an acceleration in counter price action direction.
Of course, this setup also works in the opposite direction. So look out for and be on your guard for similar setups.
