Q&A: Why does the market gravitate toward stop-loss orders?

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It is not purely that traders want to stop-out customers in order to derive some perverse pleasure. A lot of it has to do with risk management.

Let’s suppose you have a large stop-loss order in EUR/USD and you are the spot trader at Snidely, Whiplash and Company.

The definition of a stop-loss is an order that becomes a market order once a certain price is dealt. So if you have an order to buy EUR 500 mln 2 pips above a key technical level, you need to be a buyer at a point when many others in the market are likely to be buyers as well.

What can you do?

Two things. You can wait for the market to deal at the price where the stop is set and then try and execute a large order at the next price, likely pushing the market against the customer. Customers hate sloppy fills on stops, so you may end up eating a loss…

Or you can begin buying once you get close to the stop in anticipation of the order being filled. As a dealer, you go long ahead of the buy-stop and fill the customer close to his order level. The customer is thankful that his stop was done at an attractive level and the dealers books a profit while limiting the risk that the market runs away from him.

But there is a downside. What if you buy ahead of the stop and it is never triggered. You have a position that you need to manage that very well could turn into a losing position.How often do we see markets get close to a level where there are lots of rumored stops only to reverse as dealers have to bailout of positions taken in anticipation of filling those orders having to liquidate? Pretty often.

Keep that in mind the next time you get ticked at your dealer for “running your stop”. Very often they’ve taken risks on your behalf that did not end up working out for them…

13 Comments

  1. Great post Jamie.

    I do like to execute trades in anticipation of stops gettting tripped on certain pairs. From my fairly short experience, stops tend to get tripped more so than they are defended.

    But with your wealth of experience, generally speaking, during your career, do you tend to see stops tripped or defended in the majority of cases? Or will we never really know :).

    Thanks as always Jamie.

  2. Thanks Jamie. Can’t be any clearer than this!

    When you have time, it would be really good if you could do a Q&A on where is the best place to place stop loss point and target profit point, in the event where you guys in Forex Live informed us with various useful information such as selling orders, buying orders, barrier, etc etc. I am generally quite happy with how I choose my entry point, but the exit strategy is always more tricky when I realise that market has gone to the right direction but has not quite reached my target yet…

  3. Priceless post. Cheers a lot.

  4. It’s not necessarily that they are defended…sometimes the market just runs out of gas…

  5. Presumably if the dealer had an order to buy and the price was falling the dealer would still want to buy into stops below current price, so either way in your scenario Jamie or the mine the stops would be targeted?

  6. great info.
    Thank u

  7. very valuable post, Jamie. Thanks.
    Is the dealer buying on his account or on the client’s account when he buys in anticipation? if its on his account, then does he turn around and sell it to the customer’s account when the stop is hit? And if the stop is not hit, he takes a loss on liquidating his anticipatory buys. Is my understanding correct?

  8. Umm, I think so, yes.

  9. Is it safe to assume then that if the customer opts to bail out ahead of the stop order level being reached that the dealer will not take very kindly to him/her?

  10. Thanks Jamie. Could you maybe flesh out an example using “actual” figures from a recent situation?

  11. thanks jamie. that clears up many things. adding to the above picture: the dealer might also buy a bit more on his account to profit from hitting the stop and selling into the market. isn’t this what would be called front running in the stock market?

  12. Amazing post…this is the kind of insight a retail small boy can only gain in one place i.e. forex live. THANKS A LOT JAMIE

  13. @ Charles T………….. What works for me in regards to when and where to take profit is with Price Action, through Pivot Point and Support/Resistance lines. Then I know to TP just a few pips short of the line. And a few pips away on the other side of the other line with SL.

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