Stop Hunting

Stop hunting is a strategy that attempts to force some market participants out of their positions by driving the price of an asset to a level where many individuals have chosen to set their stop-loss orders. The triggering of many stop losses generally leads to high volatility and can present a unique opportunity for investors who seek to trade in this environment.

Understanding that the price of an asset can experience sharp moves when many stop losses are triggered can be useful when seeking potential trading opportunities. For example, assume that ABC Company's stock is trading at $50.36 and looks as though it may be heading lower. It is possible that many traders will place their stop losses just below $50, at $49.99, so that they can still hold onto the shares and benefit from an upward move while also limiting the downside. If the price falls below $50, traders expect a flood of sell orders as many stop losses are triggered. This will then will push the price lower and give some traders the opportunity to profit from the decline.

Stop-loss orders are types of orders that are slightly more complicated than a traditional market order or limit order. In a stop-loss order, an investor will place an order with her broker to sell a security when it reaches a certain price. For example, if you own shares of company XYZ Inc., currently trading at $70, and you want to hedge against a significant decline, one option would be to enter a stop-loss order to sell your XYZ holdings at $68.

If XYZ moves below $68, your stop-loss order is triggered and converts into a market order. Your XYZ holds would be liquidated at the next available price. Stop loss orders are designed to limit investors’ losses on a long position. In addition, a stop-loss order can protect a short position, as well.

Stop hunting is a form of trading strategy. Somewhat separate from fundamental investing which relies on intrinsic characteristics of a company, including its revenues, earnings, margins, and management track records. Trading strategies focus instead on timing and technical indicators, such as double-tops and chart trajectories. Trading strategies rely sets of rules that define certain conditions that must be met for a trade entry and exit to occur. Such specifications could include filters for company size, historical results, and triggers.