FOREX Market "Stop Hunting" - What is It?
You've probably seen it mentioned in various trading forums. It may have even happened to you a few times. It's enough to make your head explode. What is it? It's called Stop Hunting.
Here's a typical trading situation. You're convinced that the USD/JPY is heading up. You've entered a long position at 123.40 and you've set your stop at 123.05, slightly below an obvious double bottom. You set your initial target at 124.50, giving you more than a 3:1 ratio of reward to risk. Unfortunately, the trade begins to go against you and breaks down through the support. Your stop is hit and you're out of the trade. You're sure glad you had that stop in place! Who knows how far it could drop now that it's broken that support, right?
Wrong. Guess what happens next. You got it...after taking out your stop, the price turns right back around and heads north, just as you originally thought it would. As you watch from the sidelines, the pair moves up past 124.00, then 125.00, and never looks back. Just maddening. You start to think, "If only I had set the stop just a little lower. What lousy luck!" But is this really just a case of bad luck?
Let me relate one of my own recent trading experiences. Based on a statistical trading tool that I use, I went short the AUD/USD at around 0.7530 and placed a stop up at 0.7570 which was above a local top. I was looking for the price to decline to below 0.7300 over the next few weeks. Within a day or so the price spiked up, took out my stop and then moved back down into the consolidation area at around 0.7540. Now, because of this last spike, there were two local highs on the chart near 0.7570. Not to be deterred from my trade, I re-entered my short position in the 0.7530 area, and this time I put my stop at 0.7580, just above the last spike. After all, what were the chances that the price would break through that resistance again? Well as it turned out, that's exactly what happened! The price spiked up and hit my stop again, knocking me out of the trade for a second time. And even more frustrating, as soon as my stop was hit, the price turned right back down again in the direction I had originally anticipated!
Ian Fleming's character, Goldfinger, once said, "Once is happenstance, twice is coincidence, three times is enemy action." (Play James Bond music here...)However, I wasn't actually paranoid enough to think that someone was specifically picking off only my stop orders of course. First of all, my trades were so small that no one would bother trying to pick them off, and secondly I was doing these trades in a practice demo account! But I bet I wasn't the only dunderhead that was putting my stops in that obvious position just above the recent highs. There were probably quite a few buy-stop orders in that price area, and it certainly looked to me like someone was gunning for those stops. This hypothetical someone may have been a stop hunter.
So what's a stop hunter and what's all this stuff about picking off stop orders? A stop hunter is a market player that attempts to trigger the stop orders of other traders for their own benefit. They generally have the capability to move the market by a small degree for a short period. The stop hunter may be a FOREX broker's dealing desk which is trading in competition with its customers or it may simply be a large player in the market; a bank, a hedge fund or whatever.
Stop hunters operate best in an environment where most traders believe that the market is about to move in a certain direction. As traders take positions, the inexperienced ones (like me in the trade above) will place their stops at obvious places in order to cut losses if the price moves in the other direction. The stop hunters know where the amateurs are probably placing these stops, so they try to move the market enough to trigger them. This may allow a stop hunter to enter a trade at a good price before the market begins its move in the direction that everyone expects.
For example in my short trade above, there were a lot of indications that the market was headed down. Stop hunters knew that a lot of traders had taken short positions, and had probably positioned their buy-stops up at the 0.7570 area. So why should these savvy stop hunters enter a short position at 0.7530 when so many willing amateurs were willing to buy from them at 0.7570? So they proceeded to push the price up to 0.7570, and when my buy-stop order was triggered up there, guess who I was buying from? Exactly...the stop hunters who were selling to me at a great price (for them). Now I was out of the market, and they had taken over my short position at a price 40 pips above where I entered it. I had a 40 pip loss, while they entered at a price that was 40 pips better than they otherwise could have. Then, when the market headed down as we all expected it would, the stop hunters were laughing all the way to the bank while I was sitting on the sidelines pulling out what little hair I have left!
Note that a situation in which everyone expected the market to move up would work in just the opposite fashion. The amateurs would have their sell-stops at some obvious point below the market, and the stop hunters would push the market down in order to trigger those sell-stop orders. Then the amateurs would be selling out of their long positions in a panic while the stop hunters were buying from them at great prices in expectation of the coming move north.
The type of stop hunting that I've just described is used in situations where most market participants expect the price to move in a certain direction. In this situation, both the savvy stop hunters and the amateurs have the same market opinion; they are not battling each other in a contest of bulls vs. bears. The stop hunters are just trying to take over the positions of the amateurs at a good price.
There is another situation in which stop hunters try to move the market toward a group of stops in the hope that triggering the stops will push the market further in the same direction, thus triggering even more stops and so forth in a snowball effect. This is how some short term panics and rallies are created. In this case, the stop hunters have taken positions in the opposite direction from the amateurs, and are simply trying to trigger the stops to get the amateurs to panic and keep the ball rolling in that direction. My guess is that this tactic is more prevalent in less liquid markets like stocks and futures as opposed to FOREX.
In my next article, we'll talk about how to place better stops and how to plan a trade to benefit from the stop hunters instead of letting them eat your lunch.
Scott Percival is the Director of Research for the FOREX Statistical Research Center at Market-geeks.com, a site which is devoted to using mathematics and the scientific method to study the behavior of prices in the FOREX market. Mr. Percival has a degree in Civil Engineering from Northeastern University, and has worked as a Registered Representative and trading instructor at Fidelity Investments. He is currently working toward the goal of becoming a full time FOREX trader. Market-geeks.com
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The MACD (Moving Average Convergence Divergence) indicator can add a degree of certainty to your Forex strategy.
As with any indicator, it is too risky to enter trades on this signal alone. However, as we will see, used with caution on higher time frames, it can help confirm you are going in the right direction and that your trade is higher probability.
First, let?s take MACD apart and describe it?s component parts.
The default MACD on most charting packages sets 2 EMA?s (Exponential Moving Averages) at 26 and 12 days.
This is represented by a colored line (color varies according to charting package) which crosses a different colored 9 EMA often termed the trigger line.
When MACD (the 12/26 EMA) crosses above the trigger line (9 EMA) upward momentum is indicated and vice versa.
A center line, or zero line, often called the water line is also shown in the MACD indicator. When MACD is above the water line an upward trend is indicated, when it is below the water line, a downward trend is indicated.
MACD also includes a histogram, small vertical lines that appear above or below the zero line, not unlike mountains and valleys in appearance.
MACD is a lagging indicator which follows price action.
The histogram is an indicator of MACD. So watching the histogram can give you an early indication of where MACD is going. The height of the histogram can be a good momentum indicator.
How can you use MACD to your advantage?
If you want to be very cautious in your Forex strategy, going only for high probability trades, then pay attention to MACD on the 4 hour and 1 hour charts.
Some traders will only enter a trade when the 4 hour and 1 hour MACD?s are going in the same direction. This will mean a lot less trades but the ones you do take are likely to be profitable. (Agreement of the two MACD?s is used in conjunction with other indicators, not by itself.)
MACD on the 1 hour chart is particularly powerful. If you want to stay out of trouble and avoid trades you might later regret, NEVER trade against the direction of the 1 hour MACD. To do otherwise is not necessarily foolhardy if you know what you are doing.
But for the newer, less experienced trader, only trading long when MACD has crossed up, or short when MACD has crossed down on the hourly chart when your other favorite indicators line up, will make for a higher success rate with your Forex strategy. It will also save you much anxiety!
To see the above information presented graphically, follow the link in the Resource Box.
