Stop-loss hunting by big players
The international currency market has quickly gained popularity due to the possibility of active use of borrowed funds (leverage) by traders. In the financial markets, the standard leverage is only 1:2; in the option markets – 1:10; in the futures markets – 1:20. In the Forex market leverage can reach values of 1:500, which allows traders to count on potentially high profits (for more details on the correct use of borrowed funds you can read in article 10 of the methods of risk management in Forex.)
For example, in the futures market, a trader needs to have $2,500 to manage assets worth $50,000, and in the Forex market – only $500 or even $100. However, the possibility of using large leverage carries significant risks, which may lead to a complete loss of capital by a trader.
A Forex trader can literally double his capital or lose everything in a matter of hours if he uses the maximum available leverage. Most professional traders limit their leverage to 1:10 and avoid excessive risk. No matter what leverage is used for trading – the general rule of successful trader is the obligatory setting of stops. In this article you will learn how to avoid placing stop-losses in the spotlight of major players.
Active use of borrowed funds on Forex forces the majority of clients of brokerage companies to use stop-losses to limit losses and keep the possibility of further participation in trading. The strategy of “loss experience”, which is actively used by stock market participants, is not suitable for traders in the Forex market. Ignoring stop-losses eventually leads to a margin call.
Most Forex traders are speculators and are unable to survive unprofitable transactions due to the use of leverage (for more information on creating your own trading strategy, see the Forex article). Development of a trading strategy) Leverage and the widespread use of sufficiently unified stops have led to the emergence of a strategy of “breaking stops” by large players.
Despite the negative attitude of the majority of market participants towards this trading practice, it is quite legal.
As part of this strategy, large speculators push prices to stops in the hope that they will trigger and then form a strong directional movement. The strategy is so often used in practice that almost every trader from time to time becomes its victim and suffers losses.
Since the human brain requires orderliness, the majority of stop-losses are set by traders in the area of integer price levels. For example, if EUR/USD trades at 1.2470 and grows, traders place stops several points above 1.2500, not in the area, for example, 1.2526. This fact is extremely important and demonstrates the need for retail traders to use less typical and common levels for stop-losses. However, more interesting, from the trader’s point of view, is the possibility of getting profit from the directed movement formed as a result of “stops’ failure”.
The strategy is described in detail in the book by Katie Lien “Intraday trading in the foreign exchange market” (2005). Katie tells readers about the possibilities of joining a short-term trend in case of “stops failure” when passing through integer levels.
Make the most of it
It is quite simple to benefit from the situation of “stop-losses” – nothing is required but a price chart and one indicator.
Example: On the hourly chart, draw lines 15 points above and below the integer price level. For example, if EUR/USD is approaching the value of 1.2500, it is necessary to indicate the levels of 1.2485 and 1.2515. This range is called “trading”, i.e. market participants have a high chance to make a profit if the price is in this range. The idea is simple – as soon as the price approaches an integer level, speculators will try to “break” the nearby stops.
Since the Forex market is decentralized, no one knows the exact number of stops at this price level, but traders can expect that a breakthrough of one level will lead to an avalanche-like breakthrough of other, more distant levels, resulting in “acceleration of the price” in this direction.
Thus, in case of an upward movement of EUR/USD in the direction of 1.2500, the trader takes 2 long positions at the level of 1.2485. The stop-loss must be located at a distance of 15 points from the entry point. If the price does not go down to 1.2500, the probability of a breakthrough of this level is significantly reduced. The target profit level on the first position is 1.2500; after passing this level, the trader moves the stop on the second position to the breakeven point, thus fixing the total profit.
The target level for the second position is located 2 times higher than the target level for the first position (at the level of 1.2515), which allows you to earn on the price spike. In addition to tracking key levels, a trader must follow certain rules.
Since this strategy is based on the use of trading impulses, the trader should open positions only in the direction of the main trend. There are a lot of technical analysis tools to determine the trend, however, in this case, the most effective indicator is a 200-period simple moving average (SMA) superimposed on hourly charts. The use of long periods on short-term charts allows you to correctly determine the general trend and filter out short-term sawtooth price movements.
Let’s consider a practical example of using the above strategy.
On June 8, 2006, the EUR/USD pair trades well below the 200-period moving average, which indicates a strong downward trend. (Figure 1). As prices approach 1.2700, the trader opens 2 short positions at 1.2715 with a stop-loss at 1.2730. In the example above, the top-down moment is very strong because the level of 1.2700 was passed within 1 hour. The first short position is closed at 1.2700 (15 pips) and the second at 1.2685 (30 pips). Thus, the trader risked losing 30 points (two positions of 15 points each), and received 45 points of profit (15 points + 30 points).
Figure 2 shows several trading opportunities, which could be used by traders on June 8, 2006 on USD/JPY pair within the framework of the strategy described above. In this case, the pair trades over 200-period moving average, so the trader should open only long positions.
At 3 am, the pair breaks through 113.85 and opens 2 long positions. Within the next hour, the pair reaches the level of 114.00, one of the open positions is closed with a profit of 15 points, and the stop-loss on the second position is moved to the breakeven point at the level of 113.85. Further, the pair rolls back below 113.85 and the second position of the trader is closed. After another 2 hours, the prices go back to 113.85 and the trader reopens 2 long positions. This time, both trader’s positions are closed with a profit, because there was an avalanche of stops of market participants, resulting in the cost of USD/JPY jumped by 100 points within 2 hours
The strategy of taking advantage of a “stop-loss” situation is one of the easiest and most effective ways to make money on Forex for short-term traders. It requires nothing but attention and understanding of the basics of price movements in the foreign exchange market, allows private traders to stop being victims of large speculators and begin to earn profits together with them.