Stop hunting is a practice employed by the ‘big boys’ in an attempt to shake market participants out of their positions by pushing the price of an instrument or asset to a psychological price level where retail traders typically place their stop-loss orders. When these stop-losses are triggered, this often leads to higher volatility and can present traders with attractive trade opportunities.
Once a trader understands that the price of a given instrument can experience explosive moves when clusters of stop losses are hit, it can be a useful tool to seek out trading opportunities. Say for instance USDSGD is trading at around 1.33 and there is a technical signal that indicates it may head lower, a typical area for traders to place their stop would be just above the recent swing high at approximately 1.3315.
Placing a stop loss above recent swing points is quite common among traders and if the price approaches the top of the red rectangle, traders could expect a cluster of buy orders to trigger, presenting on opportunity to profit from the pop upwards in price.
Stop hunting in itself is a very simple setup that requires nothing more than a price chart and one indicator. Here’s what you do. Open up a H1 chart and place horizontal trend lines 15 points either side of a round number, creating a 30 point ‘trade area’. This is the area that you’ll have a decent probability of trading from once price enters this zone.
Now, the idea behind a trading setup like this is quite simple. Basically, once price approaches the round number level, ie, 1.33, 1.34 and so on, speculators will try to target the stops clustered in that zone. No one knows the exact number or volume of stops in any particular round number zone, but traders who employ this strategy hope that there are enough orders in that zone to trigger further liquidation of positions, that is, a cluster of stop orders that will push price further in that direction than it would under regular trading conditions.
Because trading stop hunts is a pure momentum trade, if price doesn’t follow through immediately, the setup has likely failed and you can exit at a very small loss. Taking our 15 point lines into consideration, a stop hunt could be traded like so:
Let’s open up our MT4 platform and the USDSGD chart. Say price is at 1.335 for example, and is climbing toward the 1.34 level, we assume a bullish bias and draw our lines 15 points either side of & 1.34. We now have lines at 1.3385 & 1.3415. As price strikes our 1.3385 line, we enter the long trade. As mentioned this is a momentum setup so we’re expecting immediate follow through and can afford to place a tight stop of just 15 points. As price hits our round number of 1.34 a trader could take half his/her position off the table, move stops to break even, and allow the remaining position to hit our upper line at 1.3415.
The only additional rule to this simple momentum setup is that there must already be some momentum! So, we only trade in the direction of the larger trend. There are many ways that a trader can determine the trend direction using technical analysis, however the old-faithful 200 SMA can help you to stay on the right side of momentum.
This is one of the simplest and most efficient short-term trading setups. You need nothing more than focus and a basic understanding of market dynamics. Now, let’s stop being victims of stop hunts and turn the tables to join in the direction of the big players right from MetaTrader 4.
Source: Vantage FX Blog