What Is Stop Loss Hunting?
An Overview of Stop Loss Hunting
Stop loss hunting is a strategy that attempts to force some market participants out of their positions by driving the price of an asset to a level where many individuals have chosen to set stop-loss orders. The triggering of many stop losses at once typically creates high volatility and liquidity which creates an opportunity for large-scale investors.
Stop loss hunting refers to trading action where the volume and price action is threatening to trigger the stops on either side of support and resistance. When stops are triggered, price action experiences more volatility on the additional orders hitting the market. The volatility creates opportunities for traders to open a long position at a discount or pile onto a short position.
The Details of Stop Loss Hunting
Stop loss orders are types of orders that are slightly more complicated than a traditional market order or limit order. In a stop-loss order, an investor will place an order with their broker to sell a security when it reaches a certain price. For example, if you own shares of Apple, currently trading at $100, and you want to hedge against a significant decline, one option would be to enter a stop-loss order to sell your Apple holdings at $98.
If Apple moves below $98, your stop-loss order is triggered and converts into a market order. Your Apple holds would be liquidated at the next available price. Stop-loss orders are designed to limit investors’ losses on a long position. A stop-loss order can protect a short position as well.
The fact that the price of an asset can experience sharp moves when many stop losses are triggered is exactly why traders engage in stop hunting. The price volatility is useful to traders because it presents potential trading opportunities.
For example, assume that Apple's stock is trading at $100 and looks as though it may be heading lower. It is possible that many traders will place their stop losses just below $99, at $98.99, so that they can still hold onto the shares and benefit from an upward move while also limiting the downside. If the price falls below $99, traders expect a flood of sell orders as many stop losses are triggered. This will then push the price lower and give some traders the opportunity to profit from the decline and perhaps even open a bullish position on an expected rebound to the previous range.
Conclusions on Stop Loss Hunting
Stop loss hunting is relatively straightforward. Any asset with significant enough market volume will be moving in a more or less defined trading zone with areas of support and resistance. The downside stop losses tend to be clustered in a tight band just below resistance, while the upside stop losses sit just above support. Larger traders looking to add to or exit a position can shift the price action with volume trades that amount to stop hunting due to their market impact.
Generally, this will be signaled on the charts by increasing volume with a clear directional push. For example, the price action might bounce off support twice on increasing volume before breaking through. Smaller traders jump on this stop hunting behavior to realize profits from the volatility it creates in the short term. Depending on your strategy and indicators, you can participate in the stop hunting on the downside with a short position or consider it an opportunity to open a long position at a price lower than the recent trading range.
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