Around 95% of retail Forex traders will lose their entire trading account, and part of the reason is that they don’t know where to place their protective stop losses. Institutional traders – aka the smart money – are the ones who profit from your losses because there is a predictability in the way retail traders trade the Forex market. The institutional traders are notorious for exploiting these behavioral predictabilities to their advantage.
The biggest institutional traders are the banks, hedge funds, investment firms and dealing desk FX retail brokers.
At the retail trader level, stop hunting has a negative connotation because people think their individual stop losses are targeted deliberately. Nothing could be further from the truth. Institutional traders are only looking for significant clusters of stop loss orders that are gathered at visible technical levels.
Stop Hunting Explained
Institutional traders will buy at the levels most retail traders will place their stop losses at. If you’re trading at the institutional level, it’s not always easy for your order to get filled due to the size of the trade. Occasionally, in order for a big order to get filled, you actually need to generate the liquidity to get on board.
Because retail traders hide their stops at obvious technical levels, this becomes an excellent source of liquidity for the big players to be targeted.
Most common technical levels that retail traders use to hide their protective stop loss are:
- Support and resistance
- Previous swing high or swing low
- Big round numbers
- Above/below technical indicators
- Above/below chart patterns
Stop losses will be crowded around these obvious levels and institutional traders will bid the market at those particular technical levels so they can have the needed liquidity to fill their big orders at the expense of the retail traders.
How to Profit from Stop Hunters
To be able to profit from stop hunting you must first understand why stop hunting occurs and secondly, you need to be able to identify when a stop hunt will occur. A stop hunt is more likely to happen when there is a significant buildup of buy (or sell) stop-loss orders below (or above) important support (or resistance levels).
The smart money is able to hunt stops because they understand the retail trader mindset.
Once the stop orders are hit, if there is enough liquidity it will force the price to move lower and, subsequently, a cascade of stop orders will get triggered. Institutional traders will be able to take their profits and buy back at a much better price.
One of the most common misconceptions retail traders have is that the more obvious a support and resistance level is, the more reliable that level becomes.
Because you now know that this is not true, and you already know how retail traders think, you can use that information to your advantage.
Instead of going long at a clear support level which has already been tested several times, you might want to go short and trade like institutional traders targeting the stop orders below the obvious support level.
Forex Stop Hunting Strategy Conditions
A good Forex stop hunting strategy requires two things:
- Identifying clear technical levels that retail traders might use to hide their stop loss.
- Entering a position that seeks to target those stop loss orders.
If you don’t think long and hard about where you’re going to put your stop loss, then you’ll soon find that your stop loss is triggered. The Forex market exchange rate will go to the obvious stops most of the time. Don’t use the obvious levels to hide your stop, but instead, you want to put your entries where the crowds put their stop losses.