Stops & Stop hunting

August 4, 2008 at 5:23 am Leave a comment

By FX Insights

Stops & Stop hunting

First and foremost, I will never tell a trader not to place physical stop loss orders into his trade station. This proceeding commentary is based on my own personal experiences, conversations with brokers, other traders, and with bank traders.

Stop hunting and stop loss triggering has been practiced by bucket shops, brokers, and bankers ever since there was a market to speculate in. If you refuse to accept this practice exists, you are a fool, and as it says in the book of Proverbs, “a fool is quickly parted from his money”. 

Your Broker is Not Your Friend:

If you trade on a retail FX platform, through a retail FX broker, you are instantly and always in a frontline combat situation… you’re in the infantry and the enemy is just a few paces to your front and your flank. The retail FX broker is just a bucket shop, a market maker, and you are their money maker. 

As soon as you place a trade with real money your broker is hunting you down, whether you put a stop loss order in or not. Your broker has likely taken the opposite side of your trade and will try to shake you out to close for a loss. 

Why do they take the opposite side of your trade? Your broker takes the opposite side of your trade because he has a 90% probability of winning the trade. Would you take a trade that carried a 90% probability of winning? Of course you would.

When you win a trade and close for a profit the money to pay you comes out of the broker’s netcap. The broker feeds his netcap by hunting stops, shaking out traders, causing margin calls, and triggering stop losses on extended market moves. 

With 90% of retail traders losing, it’s an easy game for the brokers to play. When a trader places a physical stop loss order into his trade station, he ups the odds of the broker winning. 

Stop loss Algorithms:

Retail FX brokers pay a lot of money to have geeks write elaborate algorithms to assist them in the process of hunting and triggering stops. Your broker can see your stop loss orders and the algorithms make it possible to group them. 

It’s very much like a firing squad situation. Retail traders set stops, mostly all in the same areas, the broker’s algorithms find them, group them all together, and take them out. It’s like the traders are lined up in front of a wall in a firing squad situation. 

If you’ve placed a stop loss order I’d be willing to stake every penny in my bank account that you’ve seen your stop get hit, to the pip, only to see the market turn right around and go the other way. Do you think it’s just a random coincidence that it happens every day in the market? If you do, you will be that fool that is quickly parted with his money. 

Broker Education:

Ever notice how the brokers are quick to offer free “education” to the retail FX trader? What they are offering is an education to teach you the quickest and easiest way to give them your money. Brokers don’t teach traders how to make money, they teach traders how lose money. 

The broker can’t feed his netcap if you are winning. When you show a pattern of winning, something else happens, but we’ll cover that in a minute… let’s stay on point here…

The retail FX broker will teach traders they must place 30 or 50 pip stop loss orders. That they must use trailing stops, that they must keep their stops tight, and must use stops to avoid drawdowns. In a liquid and volatile market, using 30 or 50 pip stop losses is the surest way to give the market your money. Using those tight stops makes it the easiest for brokers to manipulate the market enough to take out those stops. 

Stops and Tech Traders:

I’m not going to beat up tech traders here, I do enough of that during the week. But I want you to realize that the banks and brokers employ brilliant tech traders. I’m talking about people that are experts on all the major technical indicators retail traders blindly use and follow. They know where all the Fib lines should be, they can read the moving averages, stochastics, etc. 

The problem for the retail trader is that the vast majority of them use those major technical indicators as a guide to place stop losses. The retail trader will place stops 10, 20 or 30 pips from Fib lines, for example. The tech-heads at the banks and brokers know this, and capitalize on this. Those poor fools who are using tech indicators as a basis for placing stops are just like lambs being led to the slaughter. 

The other thing tech traders love to do is use round numbers. This really makes it easy for the brokers to take them out. Tech traders also like placing stops at 50 and 00 levels. My best advice for tech traders that feel the need to use stops is to use odd numbers, not even numbers, and to place them more out of the reach of where the brokers will typically go to take out stops. 

Broker Dossiers:

As I mentioned above, I wanted to cover what happens when you start showing a pattern of winning. There’s another algorithm that brokers have, and this one is for winners. If you show a pattern of winning, you raise a red flag with your broker and they begin studying and tracking your trading habits. 

You hear me constantly talking about patterns in this market… well, when you show a pattern of success, your broker has to find out why and how you’re beating the market. A winner is enemy #1 to a broker. A winner takes money from his netcap. Brokers don’t like paying winners, they like taking from losers. 

The more the broker can discover about your trading patterns, the easier it will be for them to find ways to either shake you out or stop you out. This could mean widening the spreads on you, slipping you on market orders, slipping you on take-profit orders, re-quoting, etc. If you’re winning and not using physical stop loss orders, they will go to great lengths to find where your weakness is and exploit it. 

There are a lot of traders in the FXI community winning. We can probably boast the highest winning percentages out of any trading community in existence… we are rarely on the wrong side of the market here and we all work hard to beat this market. It is for this reason we are watched by the banks and brokers, why they sit in our chat room, and why they monitor our forums. 

Stops and Price Action: 

I went to a military academy that was at times mentally and physically brutal, much like the Forex market. The challenges never ceased to exist and we were constantly being pushed and stretched beyond our limits. As I write this commentary, there’s something I can correlate from those days in military academy to something that happens in this market in regards to stops and price action. 

One night we were awoken sometime after midnight and given three minutes to be in formation with our gear. They put our entire unit on a bus and drove us to an area we’d never been. We filed off the bus, formed up again, and waited for orders. 

The sergeant instructed each squad in the unit to file behind the other, starting with Alpa Squad down to Echo Squad. The order from the sergeant was this: complete a 4-hour night hike in a swamp, without any light sources. This was mandatory. Then came the extra challenge – if we completed the night hike and then found our way back home before sunrise we could skip Saturday morning inspection and sleep in. 

This was a huge deal… being able to skip inspection and sleep in… it really didn’t get any better than that for us in those days. Basically, if we pushed ourselves a little further, we would be given a wonderful reward. 

I liken that story to how stop losses and price action work hand-in-hand. When I’m watching and trading based on real-time price action moves in the euro, and I see that we are getting close to an area where stops are placed, this gives me a tremendous amount of clarity and ups the probabilities of a trade. 

As like that story, when the banks and brokers push the market just a little further to trigger those stops, the rewards are tremendous. For example, lets suppose the euro has moved up 200 pips bottom to top and we’re getting close to an area stops are placed, what do you think the probability is of the market pushing another 10 or 20 pips further to attain a wonderful reward? The probability is almost off-the-charts high. It’s almost always going to happen. 

It is imperative you consider this: fundamentals are fudged and manipulated, technicals are lagging and unreliable — the only honesty this market will ever give you is through price action.

Stops or No Stops:

The main reason I do not place physical stop loss orders is because each trade I take is taken after a set of distinct criteria is met, even if it only takes me 30-seconds to see that a trade meets this criteria, it’s still totally thought out and executed based on a set of rules and guidelines. 

As a trader in the Forex market there’s exactly two things I seek and these two things are what keep me motivated to work so hard, to put in the time and energy, and to devote my life to this market for the time being:

1. Being right 
2. Being on the right side of the market

I do not like to be wrong and I do not like to be on the wrong side of the market. The brutality of this market allows for no margin of error. This market is too violent to allow for traders to take knee-jerk trades and to mismanage risk. This market is not for the emotionally and mentally weak and unstable. 

I hope you find this commentary clear and concise. That was my goal – to spell it out as simple as I can. If you have any specific questions on what you’ve read, please ask in this post. Thank you.

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EUR/USD Weekly Outlook – – 8/3 thru 8/8 2008 +1 Risk/Money Management Technique

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