Generally speaking, Forex brokers do not hunt stop losses. It is usually someone else engaging in this activity. However, selecting the right broker is vital in protecting yourself against this.
Your broker is one of the most important components when it comes to your long-term trading success.
This is true whether you are a brand new retail trader with a small account, or a professional trader with a few million under management.
Is Your Broker Trading Against You?
When choosing a broker, you need to determine whether they are on your side. Specifically, you need to find out whether they trade against your positions.
This sounds like a contradiction, as a broker is the middle man between you and the currency markets.
The traditional business model of a broker is simple. A broker pools client capital together, which makes them big enough to access the liquidity needed to trade.
As you trade, you then pay your broker a small commission for arranging this access.
Without the broker, you would not be able to access the FX market. Banks would view your business operation as too small.
When Brokers Get Greedy
Problems arise when brokers try and maximise the profits they make.
Some brokers have recognised that most new traders fail to make a profit. In fact, the majority lose their money within a few months.
To take advantage of this, many brokers do not act as the ‘middle man’. Instead, they become an active market participant. They do this by taking the other side of your trade. This means that when you place a buy or sell order, your broker will open the opposite position.
Forex traders call this ‘market making’. Brokers that follow this business model describe it as having a ‘dealing desk’.
Naturally, you might feel that this is a huge conflict of interest.
You’d be right. Any broker with a dealing desk or acting as a market maker profits directly from your losses. They also lose directly from your gains.
This also means that the broker cannot stay in business if most of their clients are profitable.
Market making is why the regulation of brokers is so important.
A good regulator will give the broker strict standards to adhere to. If the broker breaks the rules, then the regulator will step in and punish them.
Brokers that operate is less then credible jurisdictions are a cause for concern. Generally, low tier regulators do not have the appetite for maintaining high standards.
The most respected regulators in the world are the FCA (UK) and the NFA (US). They consistently uphold high standards and punish offenders.
Other regulators have had a difficult time being consistent in their operations.
Your funds are at risk if you use a broker in a loosely regulated territory. They could be manipulating the market to hunt your stop losses. Of course, operating in a low tier territory isn’t a guarantee that this is happening. But it is a possibility.
My advice is to use a broker that abides by US or UK regulation. You can then be sure of the organisation’s integrity.
Stop Loss Hunting
Regardless of your choice of broker, stop loss hunting is something you need to be aware of.
Most stop loss hunting occurs outside of the broker/client relationship. If you are not aware of this phenomenon then your money is at risk.
What Is Stop Loss Hunting?
Stop loss hunting is a practice conducted by larger traders against smaller traders. Larger traders conduct this practice to maximise their own profits.
Let’s consider an example that involves selling a currency pair.
Stop Loss Hunting Example
Imagine that a large hedge fund wants to sell a currency pair, as they believe it has a strong chance of falling.
If there is a strong conviction in the coming move, then it is highly likely other traders will have the same idea.
So, traders will enter the trade and then place a stop loss to protect them if the trade goes wrong.
Most traders look at similar price levels for both their entry and stop loss placement. These levels become fairly predictable to larger players such as hedge funds.
The hedge fund knows that a lot of traders will also be selling. They know where the traders will have most likely placed their stops.
They can glean this information through a simple price chart analysis. Remember, many traders place their stops above or below swing points on a chart (please see the below chart).
The problem that hedge funds have is that they are too big to just enter the trade. If they sell 100% of their position at once, they will experience slippage and receive a worse price.
To avoid this, they will look to enter where there are a lot of counter orders to fill their trade. For example, if they want to sell $10 million, they need $10 million of buyers at the same price.
The best way to locate a pool of counter orders is by hunting stop losses. They know everyone is selling and know the optimum level for stop loss placements.
All they need to do is push the price up into those stops to get their large order filled. This costs money, but they are big enough to move the price momentarily.
Do Forex Brokers Hunt Stop Losses?
Have you ever seen the price spike into your stop loss, only to then reverse and move in your anticipated direction?
If so, it’s likely a that a larger trader has hunted your stop loss.
Many traders think this is a practice carried out by their broker. This is incorrect. It’s actually other market participants (and it’s a very common activity).
To avoid having your stop hunted, look to place your stop in less obvious places. Don’t rely on common chart patterns that every other trader will be using.
In this article we covered broker dealing desks, why to choose a regulated broker and what stop loss hunting is.
Importantly, we learnt how to best avoid being stop hunted.
If you’re still experiencing frustration with stop loss hunting, it’s time to review your strategy. This article will help.
If you have any questions or comments, feel free to let us know in the comment box below.