How to avoid stop-loss hunting is a question all traders want to know the answer of. A stop-loss order is an order traders place to limit their losses. However, stop-loss hunting often causes significant losses to traders because prices often reverse after triggering a stop-loss order. It is very frustrating for traders. Therefore, it is imperative to know how to avoid stop-loss hunting.
If you want to learn how to prevent and protect your stop-loss orders from hunting, then you are on the right platform. In this detailed article, we are going to explain all you need to know about stop-loss, stop-loss hunting, and how to protect your stop-loss from hunting. Let’s dive deep to find out.
What is a stop-loss order?
Understanding the basics of a stop-loss order is a prerequisite to knowing how to avoid stop-loss hunting. A stop-loss order is a measure traders take to limit their losses. They set a stop-loss at a pre-determined price level to close their position. Therefore, stop-losses are among the best risk management protocols. Furthermore, stop-losses also help traders avoid emotional mismanagement and enable them to manage risk in the best possible way. How so? Because stop-loss orders close their positions at a particular price level in the worst-case scenario.
However, the gameplay isn’t a simple one. You also have to understand where experts put stop-losses and why. Traders often set stop-losses above or below certain key price levels known as areas of support or resistance. These areas actually represent areas of strong demand or supply. However, there is a problem here. These areas are quite obvious to detect and often there are clumps of stop-loss orders around these areas. So, large institutional investors might push prices lower and gain profits by hunting stop-losses. Now the question is what stop-loss hunting actually is.
What is stop-loss hunting?
Retail traders often experience that price reverses after triggering their stop-losses. The price first goes to their stop-losses, triggers them, and then moves to their target price levels. Indeed, it is nothing less than frustrating and annoying. This is stop-loss hunting and losing traders often blame brokers or institutional investors for it. However, this blame is partly just and partly unjust.
The blame is just because institutional investors do hunt stop losses for their gains. However, it is their strategy and they aren’t responsible for anyone’s losses. Traders must accept responsibility and should strive for better trading strategies. Now, if we look at another aspect and that is whether brokers also hunt stop-losses or not?
The answer is no. Most brokers are regulated and they have to abide by the compliance rules. Therefore, it is not worth hunting stop-losses. So, who is to blame? Traders are to blame and they should take responsibility. However, large institutions might hunt stop-losses. There are two reasons why large institutions hunt to stop losses. Firstly, they want to cause an increase in relative volatility that increases after stop-losses get triggered. Secondly, triggering stop-losses also allows them to enter trades on better entries. So, what is the solution? The solution is to learn and put stop-losses at better price levels.
How to avoid stop-loss hunting?
In most stop-loss hunting scenarios, traders don’t put stop-losses at the best price levels. Therefore, it is imperative to learn how to avoid stop-loss hunting.
Tips to avoid stop-loss hunting
Traders all across the globe use support and resistance areas, trendlines, or price patterns to put stop-losses. However, most traders cannot avoid stop-loss hunting despite using the same indicators others do. This is because they aren’t able to use stop-losses in the right way. Here are tips for you to avoid stop-loss hunting.
1. Support and resistance
Support and resistance levels are key price points on price charts. Prices tend to bounce back from these areas and that is why these areas are crucial. Support is a zone whereby prices typically rise after hitting those levels. On the other hand, resistance is a zone whereby prices typically decline after hitting those price levels.
Now, what do newbies or inexperienced traders do wrong when putting stop-losses? The major mistake they commit is that they only identify price levels for stop-losses. Whereas, they should actually identify a zone for better stop-loss orders. Let me explain it with an example.
Let’s suppose that a trader is looking to go long on shares of a company. When he/she looks at the price chart, they identify a support level at a price of $100. So, the trader is only considering price level and not price zone for stop-loss placement. Now, if the trader goes long when the price reaches that key support level and places a stop-loss just below that level, what would happen? There are chances that the price will trigger the stop-loss and bounce back. For instance, placing a stop-loss at $97 is a mistake.
In order to avoid stop-loss hunting, traders should identify a support zone, not a price point. So, the price zone between $100 and $95 is the better option to place a stop-loss. That said, placing the stop-loss a few cents below $95 will keep traders in the trade. The price wouldn’t trigger stop-loss in case of a short impulsive decline in price.
Additionally, it is also important to focus only on key information and ignore all the noise. If you don’t do that, you commit the mistake of placing a stop-loss at a level where the price bounces back. However, you need to know that there are numerous points at which prices often bounce back. That doesn’t necessarily mean that price will bounce back every time it hits that point. Contrarily, if you enter a trade at price points where there was a big rally, you will be spot on.
Traders also see trendlines to identify areas of support and resistance. However, there is a difference here as trend lines indicate key areas through lines connecting lows and highs. Thus trendlines can be inclining or declining.
Now, there are two approaches traders trade using trendlines. The first one is a conservative approach. It involves entering a short or long position only when the price bounces back after the trendline is invalidated. That means, traders wait for confirmation and don’t enter a trade as soon as the trendline is invalidated. The second one is a bold but risky approach. It involves entering a trade as soon as prices invalidate a trendline.
So, where should traders put stop-losses to avoid stop-loss hunting when using trendlines? They should place stop-losses above or below the recent highs or lows in the direction of the trendline slope. For instance, you spot a downward-sloping trendline on the price chart of stocks of a company. Now, you can enter the trade as soon as the price invalidates the trendline or wait for the pullback. Now, you need to decide where to place a stop-loss.
The best point to place a stop-loss in this scenario is to put it just below the lowest point the share price hit. It is important because the price may move again to the price point it bounced back from. Thus, traders can take full advantage of the strong rally prices often after a bounce back.
3. Price patterns
As you know, there are numerous types of price patterns that indicate the direction in which the price may head in the future. Experienced traders capitalize on these patterns and find the best entries for their trades. Furthermore, price patterns are of two types, reversal, and continuation. However, trading solely on the basis of price patterns is a huge mistake traders often commit. Instead, traders should use support and resistance zones along with price patterns for better trading decisions. Additionally, stop-losses are also of paramount importance because they can make or break your trades. So, where should you place stop-loss when trading on the basis of price patterns?
Again, the rule is the same. You need to place stop-loss a few points or pips below the support or resistance zone. For example, if you are planning to go long, the key is to place stop-loss below the support zone. Similarly, if you are to go short, place the stop-loss a few points above the resistance zone. That’s how you will be able to avoid stop-loss hunting and will stay in the game even if the price impulsively pulls back.
Are you among traders who blame brokers and hedge funds for conspiring against small traders? I guess you’re not, at least after reading this article. Yes, big institutional investors may use stop-losses to their advantage. They hunt stop-losses for better entries. However, brokers don’t do such things. They have to abide by the rules and regulations to keep their licenses. Conspiring against retail traders isn’t worth it for brokers. So who is to blame? Traders themselves because they often commit mistakes when placing stop-losses.
You need to understand that embracing responsibility is a virtue that leads us to betterment. Blaming others means you aren’t committed to making yourself better. Therefore, if you have been making the same mistake, it is time for a change. Use this detailed guide to the fullest advantage and learn how to avoid stop-loss hunting. Whether you use support and resistance zones or trendlines, always place stop-loss a few points or pips below the point price hit. Only this is the way to avoid stop-loss hunting as it won’t trigger your stop-loss and you will stay in the game.