Within this article, I would like to explain how the phenomenon of ‘stop hunting’ is actually conducted in the FX markets, and I would like to elaborate on a particular factor which still seems to be largely unknown to most traders. That factor is the proven habit of the so-called ‘Smart money algorithms’ to first “price in” any dumb money positions that may be in the way of the stop hunt move that is about to happen.
If one understands these two, rather basic components of the FX market structure, then a whole new range of price action can be understood and eventually predicted.
It is my intent to shed light on these (for the trader very relevant) components within this article and to present various real-life examples which can help the reader to better understand these dynamics.
Understanding ‘stop hunting’
Firstly, let us take a step back and think about the reasons for the SM Algos to hunt stops. By luring the dumb money traders into accumulating their stops in certain zones, the SM can eventually move the price to these areas, which will then result in the DM traders booking actual cash losses; this while the SM Algos book these pips as profit. In a way, a stop hunt is a “final blow” in the duel between the SM and the DM. It is the moment when open drawdowns are converted into actual cash losses for the DM, when some DM traders suffer margin-calls (the ones who were over-leveraged) and when some DM traders manually close their positions and book the respective loss. As a footnote, the traders who still try to “hold over” the open drawdown when the price goes against them, we often call “sticky DM”; because they will suffer from increasing swap rate costs over time, and they are not able to implement an overall profitable trading system with that approach (of simply holding over any losses).
As you can already see, the SM thought of everything. So to speak. Their exclusive ability to move the price of a currency in a particular direction is the equivalent of a poker player who knows what the next ‘card on the table’ will be. It is an unfair game indeed.
What is the ‘psychology’ of stop loss hunting?
Let us return to the previous aspect. Yes, the SM will eventually conduct the ‘stop hunt’. However, what is completely unknown to many traders is that for each of these ‘stop hunt moves’ there will first be a number of ‘counter-moves’. Yes, that literally means that on average, before the actual ‘target run’ is performed, the SM Algos conduct (at least a handful) of price moves AWAY from that target zone.
Why do they do that?
The answer is ‘DM positions’. The DM traders constantly place positions and orders in the market. The SM is able to see these, with their respective price levels. Think about it. If there is a stop-accumulation 50 pips above the current price of EURUSD, but if 30 pips above the price there are open DM positions which are “long” (so buyers of the market), then the SM Algos would allow these “longies” (as we call them) to get into profit.
Make no mistake, the SM could still take the upper stops of the DM shorties. However, in that process, it would allow the existing DM longies to get into profit, since there entry prices were below the stop-accumulation above. If the SM Algos would still go ahead and go for the stops, this despite the DM longies are placed “in the way”, then over time, that would be a trading approach that could be profitable for the DM traders. For example, they would try to “buy around highs” and “sell around lows”, assuming that in most cases, these will be cleared and their positions are let into profit.
So as you can see now, there is no reason for the SM to allow that to happen. Rather, they will do their very best in order to “shake off” or “thin out” these long positions. How can they do so?
By conducting price moves in the opposite direction, in our example, down. As a result, the DM longies will see an increasing loss. The ones with tight stops will be stop-hunted. The ones who are over-leveraged, will either get a margin-call or be forced to take a loss.
Stop loss hunting moves, counter-moves & profitable trading
These ‘counter moves’ are done in a way that the factor “time” and the factor “range” are exploited as much as possible. I have called that “time & range principle”; the SM Algos implement this price action and is not in a rush to do so. Because the SM has full price control. The stops are rarely moved away. Often, they are actually moved closer, as a result of the counter-moves.
That is the “dance of prices” in the FX markets. In a nutshell, the SM Algos will try everything in their power in order to make sure that the DM traders (as a collective) will lose. Independent from whether they bought or sold the market. Independent from whether they intent to “trade reversals”, or “pullbacks” or “breakouts”. In the end, what matters, is where the overall targets are and how the SM Algos first have to ‘clear the way’ towards these.
Not many traders or economists understand these basic realities in FX. I have termed that approach the “market causality approach”, because prices in FX are not random at all. Instead, we have a “cat and mouse game”; and the reward for that game translated into pips, one way or another.
How to identify SL hunting?
In order to better demonstrate these dynamics, I will now present various examples from real life.
Let us look at a real-life example, like here in AUDUSD at the beginning of November 2024. As it can be seen from the first screenshot, there is a main target above the current price (green line). It is what we call an “MTS”, a “medium-term stop accumulation”. So we know that eventually, the SM Algos will push AUDUSD up and take the target out. However, we can already clearly see that “on the way” to that clear target, we have quite some “DM long positions”, these are shown on the y-axis as green bars. So we have here the situation we discussed before; rather than instantly conducting a move up, the SM Algos will FIRST do their best in order to “shake off” or “thin out” these DM buy positions.
And this is exactly what happens (see next screenshot). The SM Algos push AUDUSD down first. They clear all the lows; all the stops which DM longies had placed there. By doing so, more and more DM longies cash in their losses; this with every pip the SM Algos push the market down.
Once that has been done, and the ‘time & range principle’ had been exploited as far as possible, the SM shows its true hand and pushes AUDUSD all the up to the actual main target, taking it out (see below).
This is how FX works. Every single price action you can observe on lower and higher timeframes is the output of that equation. The SM moving the market price in a way that literally ensures that the vast majority of DM traders will end up booking losses on their positions.
Now, you may say “but some DM longies were ‘sticky’ here”, and that is true. There is always what we call a “DM tolerance”.
DM tolerance refers to the DM positions which were tolerated to slightly get into profit, this AFTER the factors ‘time’ and ‘range’ have been sufficiently exploited. Without the DM tolerance, the price would not move as much as it does. We actually have dedicated indicators which show the degree of the DM tolerance in an objective way, but that topic is for another article in the future. The ‘market causality’ is a COMPLETE and coherent approach to the FX market structure (with respective technological tools), no stone was left unturned.
Liquidity grabs
But always be aware of the dynamic that was explained in this article. In general, for every ‘main target run’ towards a stop zone, there will be at least a handful of previous counter-moves. These moves are often ‘liquidity grabs’, such as moves to fill an open ‘order gap zone’ (OGZ). Sometimes, the SM lets the market go sideways for ten hours. Sometimes, the DM implements an exaggerated counter-move and the DM responds by moving their stops further. Sometimes, the market develops into a ‘squeeze mode’ and the SM prioritizes that dynamic over another. But these are more advanced topics.
For now, understand that the “dance” I have described above is a daily reality. Do not get lured into falling victim to it. Instead, have the right tools at your disposal which improve your chances of trading in a better way, despite all that market manipulation going on in today’s markets.
I hope you enjoyed that article and that it helps you on your journey to become the best trader you can be.
All the best,
Djamal M. Adib
CEO SME Limited