Why do dealers gun for stops?

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Mark asks, ‘why do dealers gun for stops, that doesn’t seem very nice to me?’. Fair point and fair question Mark which we can add to our Q and A section.

Lets look at an example of an interbank dealer who is looking at his order book and sees stop-loss orders to sell 200 million EUR/USD at rates below 1.3700 down to 1.3690. The current rate is 1.3730 say. He has some options:

1. He can do nothing. He waits until the market breaks below 1.3700 and then he starts selling. The danger with taking this course of action is that other dealers have similar order boards and the market gets fast below the level. The customers might be filled 10 pips or more below their stipulated level and they would not be happy. Plus the dealer doesn’t earn anything from this.

2. He sells 20 at 1.3730. The market starts drifting lower so he sells another 20 (if the market goes up he cuts the 20 short position for a small loss). He may buy 10 back but keep himself 20 or 30 short. Lets say his average entry rate for the 30 short is at 1.3730. When the market breaks below 1.3710, he sells another 30 and then he sells 100 at 1.3700 to ensure that the market trades at a rate below 1.3700. Then he sells the balance of the orders. He will have sold 200 EUR/USD at an average rate of 1.3706 say. He will fill the stop-loss sell orders on average at 1.3696, with each customer being filled at their stipulated level. The dealer will have ensured that the customers cannot complain about slippage and at the same time he’ll have earned $200,000.

All dealers will follow the second course of action which in essence means that all stops are targeted.

There is sometimes a downside risk in that the dealer may sell 100 EUR/USD but the market suddenly stalls at 1.3700 due to a barrier or a big Sovereign or corporate buyer. If this happens the dealer must act very quickly to start covering his shorts before the market races higher.

19 Comments

  1. I welcome Sean!
    Having carried out the certain analysis of the future markets, has come to such result… It is necessary to pay attention to more low listed markets as on them at least 3 indicators signal that shortly the price or the rate of exchange can fall or grow (depending on a signal).
    So, actually here what results have turned out (the given analysis I has made the first time if there will be an accuracy the second time makes sense to repeat it)
    Signals on price strengthening:
    Gold
    Signals on reduction of price or the rate of exchange:
    Euro
    Canadian dollar
    The British pound
    Mexican peso
    The Swiss franc
    Oil (Crude Oil)
    Fuel impurity RBOB
    Copper
    Platinum
    Wood
    Cocoa
    Coffee
    The grain: Wheat, Corn, Oats

  2. Hi Sean, after reading this great explanation, i have one doubt about the strategies used by professional traders.

    If i understand it, the profit will be 200.000 because the target is 10 pips.

    My doubt is if is: The professional traders use 10 pips as stop profit and 10 pips as stop loss?

    Thanks ;-)

  3. how come no.2 sounds so much like god’s work to me. or am i just igorant about something?

  4. Hi Sean, regarding the downside risk where the dealers must covering his shorts, is it difficult to find a buyer in this case for Eur/Usd? i mean do the dealers need to queue to sell their shorts.

  5. Sean, hope you had a great weekend!

    Fantastic answer – thanks!

    But, at what kind of level can we be confident that the stops will be targeted? Wait until within about 15 pips of the reported stops?

  6. awesome post.

  7. That was a fantastic Write. I’m still re-reading your thoughts. Awesome work! Thanks again.

  8. Looks like US crude futures gonna make another run to 100

  9. Hi Sean, Kind of related to Mark’s question, say there are reported bids in large numbers 25 pips below the market, would dealers then want to target them? Cheers!

  10. great article Sean, if retail traders new the true value of this information and its effects on the market they would look at stop hunting in a whole new light.

    Also think you made a typo

    ‘2. He sells 20 at 1.3630′

    should be 1.3730

  11. Yes Justine, I’d say if the stops are big then within 20 pips and dealers are looking for them

  12. Thanks Peter, edited now

  13. First come first served, Essenza; you gotta be quick!

  14. Charles, sort of the opposite when it comes to limit orders. If you are monitoring a big buy order below the mkt then the tendency is to get long ahead of the order.

  15. Thanks Sean! I thought as much as selling into it would make no sense. So lets say we know there are big buy orders in USD/CAD circa 0.9750, then if we are pretty confident these are not going to be filled on he initial hit, we should look at getting long maybe 5-10 pips ahead them? BTW, another fantastic read with superb insight into the mind of an interbank dealer!

  16. Ed…still short S&P?….i got out Friday after it started to rise off the doji on Thurs daily chart. Looking to take a smaller short again around 1325.

  17. Sean, all things considered, do you think that using
    “physical” stops in the market is a sucker’s game for
    retail traders?…that using stops almost becomes a
    kind of self-fulfilling prophecy for paper losses to
    become realized losses? Unpredictable and meaningless
    volatility is a given in the currency market. Why
    give in to it? I think stops are overused.

    I’m just looking at stops from the opposite side of
    the dealer-gunner.

  18. You are a beast Sean

  19. Well thats just one dealer…there’s plenty others with different objectives and orders to work.

    And even what they “see” on interbank they too have to “read” and react to with actual price discovery. Highs , lows and figures are like magnets like to get tested and stops tends to be close by, especially retail.

    But even dealers get burried slipped and have to chase; there’s fish of all sizes chasing each other around. The best idea is to spot the big ones, step in front and lean on their size, and hopefully nothing bigger comes along to take you both out through more stops.

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