Stop running, also referred to as stop loss hunting, is the practice of actively driving the price of a security toward a desired level. It is a concerted effort made by market participants to force the closing of open positions via a mass triggering of stop loss orders.
Cases of stop running have been observed in the cryptocurrency, equities, futures and forex marketplaces. The applications can greatly influence the behaviour and price action of the targeted product. Although manipulative in nature, it is not considered to be an illegal trading activity on par with spoofing, layering, front-running and quote stuffing.
Purpose And Strategy
The methodology behind stop running is twofold. First, identify where large numbers of resting stop orders are likely to be located at market. Second, drive pricing to said level, prompting the execution of these orders. The result is a spike in traded volumes and a sudden directional move in asset pricing.
Two primary market characteristics contribute to the effectiveness of a stop running strategy:
- Price Discovery: As buy or sell orders are sent to and filled at market, price moves in relation to any imbalance between the two. For instance, if there are more buyers than sellers, price rises as the traders attempt to secure a long position. In the event that there are more sellers than buyers, price falls accordingly.
- Order Flow: Order flow is the mechanism behind price discovery. As markets move, unique buy and sell orders are executed, thus creating movements in price. In turn, more orders flow to the market as the process of price discovery ensues. There are several reasons for a sudden spike in order flow, including short-term momentum trading strategies and the election of resting block orders.
The paramount goal of stop running is to profit from the sudden, definitive move in price action created by the bulk of stop loss orders being filled at market.
Various strategies are implemented to capture profit in this scenario, including breakout trading, the use of momentum-based algorithms, short-term trend following and reversals. Many of these approaches are executed through the use of automated, black-box and high frequency (HFT) trading systems.
At first glance, stop running appears to be outright market manipulation in violation of numerous international regulatory guidelines. For instance, stock market manipulation is considered illegal by the U.S. Securities Exchange Commission (SEC). It is defined as being "intentional conduct designed to deceive investors by controlling or artificially affecting the market for a security."
Prohibited activities are outlined as follows:
- Spreading false or misleading information about a company
- Improperly limiting liquidity
- Rigging quotes, prices or trades
- Creating a false picture of the demand for a security
The European Securities and Markets Authority (ESMA) puts forth similar restrictions governing "market abuse." However, the practitioners of stop running strategies are, in fact, assuming risk. If their efforts are met with adequate resistance, the possibility of capital loss is very real. Unless parties with order book access such as an intermediary or brokerage service are involved, then it is a lawful and legitimate trading strategy.
Stop Running In Action
Regardless of regulatory concerns, stop running remains a viable approach to the markets. The methodology is fairly straightforward: identify the exact price points where a large number of stop losses are likely to be located, then drive price to that level. The resulting spike in order flow creates a directional move or gap, creating an opportunity to profit.
The following scenario facing the EUR/USD illustrates the basic structure of a stop run. Assume the going rate for the EUR/USD is 1.1615, the previous day's low is 1.1600, and the daily trend is up. Given this scenario, a plausible stop running strategy may be executed as follows:
- The 1.1599 level is identified to be saturated with stop out orders for day and trend traders holding long positions.
- A stop running strategy is put in play via concerted selling from the 1.1615 level, driving price to 1.1599.
- Upon price falling to 1.1599, order flow spikes, with a volume of sells hitting the market.
- Rates move directionally, featuring a rapid drop beneath the 1.1599 level.
Veteran traders are aware of the impact that stop running can have on the markets. A winning position may be liquidated prematurely, or losses magnified. In order to mitigate the negative influence of an ineffective stop loss, trading plans are designed including provisions anticipating stop running activities. Among them are avoiding price points commonly targeted, like those listed below:
- Obvious Extremes: A product's daily, weekly, monthly and yearly high/low values are often used as a basis for stop loss placement.
- Intraday Extremes: Price discovery is an ongoing process during open market hours. Periodic and established high/low intrasession values are frequently used by day and intraday traders to calibrate risk vs reward ratios.
- Round Numbers: Obvious to all market participants, round numbers are highly public and commonly used for both market entry and exit.
- Technical Levels: Traders and investors typically use technical analytics such as Fibonacci tools or moving averages to determine stop loss placement. The more popular the indicator, the greater the chance it will be targeted.
In nature, plants and animals on the lower portion of the food chain utilise a variety of means to deceive predators. Camouflage, heightened senses and speed are just a few attributes that keep prey alive. The marketplace is no different. Wise retail traders implement numerous safeguards to defend against stop running. Unconventional order location, price alerts and manual order entry are a few strategies used to protect against stop running practices.
Over the past two decades, trading technology has increased exponentially. Market data, order entry and execution latencies are now measured in terms of milliseconds instead of minutes. Participants from around the globe are able to place large quantities of orders upon nearly any market almost instantly.
Subsequently, periodic spikes in both volatility and traded volumes have increased. This aspect of market behaviour has incentivised the practice of stop running, making it a viable trading strategy for those with ample resources.
FXCM Research Team
FXCM Research Team consists of a number of FXCM's Market and Product Specialists.
Articles published by FXCM Research Team generally have numerous contributors and aim to provide general Educational and Informative content on Market News and Products.
Retrieved 02 Oct 2018 https://www.esma.europa.eu/sites/default/files/library/esma70-145-111_qa_on_mar.pdf
Retrieved 03 Oct 2018 https://www.marketwatch.com/story/why-i-stopped-using-stop-loss-orders-2013-05-09