The Institutional Hunt in the Foreign Exchange Market

The Stop Hunt

The Foreign Exchange market, also known as Forex is one of the most fascinating financial markets in our era. To the naked eye forex trading is about buying and selling foreign currencies in an attempt to profit over the price differentials.

The strength or weakness of a particular currency is reasoned by supply and demand, which is determined by economic data or various technical strategies. However, there is another intraday element that shifts the FX rates in the markets. There is a constant war amongst institutional traders in the Forex market. This war is labelled as ‘stop hunting.’

Stop hunting occurs when a concentrated amount of stops are found in a tight price region, often below support levels or above resistance levels. There are multiple reasons why those stops are hunted which we will not elaborate on in this article.

Aside stops, entry orders such as but stop, buy limit, sell stop and sell limit are also hunted by key market players. There is an intense war behind the curtains to gun down those orders that many traders including seasoned traders are surprisingly unaware of it.

Although it is rare, it is possible to capitalize over an aggressive stop hunt as we have successfully done in our forex signals in GBPNZD. See GBPNZD signal.

The Forex Algorithms

Due to the hefty liquidity that is seen during the European session it will be extremely difficult to conduct stop hunting operations. The optimum market conditions would be illiquid sessions where it would be “easier” to shift the rates in a predetermined direction.

However, it is important to note that approximately 30% of the trades in the Forex market are executed via sophisticated algorithms, commonly known as black box systems.

Many algorithms are based on breakout strategies. When a key price has been breached the algorithms are likely to kick-in and accelerate the buying or selling pressure. For example, round figures are said to be crucial for breakout strategies. In EURUSD, a round figure is 1.0000,1.1000, 1.2000, 1.3000 etc.

If EURUSD is trading at 1.2010, all that is required is to push the price below 1.2000 and let the algorithms  boost the selling.

In order to have full control of shifting the market price illiquid market conditions are required. Such conditions are found at the gap between the US and the Asian session and on Fridays that by nature have less liquidity than other trading days.

Barrier Options, Hunt for Glory

Aside stops and entry orders, barrier options appear to benefit from a greater attraction to certain institutional traders.  There are many forms of barrier options, we will focus on a knock-in and a knock-out. A knock-in barrier is similar by nature to entry order.

For example, let’s say EURUSD is trading at 1.2350. A knock-in option can be placed at 1.2370 with an expiration at 1.2390. The barrier option will only become active when 1.2370 is reached.

Key market players will therefore have an interest to activate such options, which can be done by coordinating a long trades in EURUSD to ensure the price reaches 1.2370.

A knockout option is active as soon as it placed and must remain above or below a predetermined price level until the option expires. For example, an option can be placed in EURUSD while predicting the price will not break above 1.3000 until the option expires.

The option holder is likely to layer short entry orders in the sport market between 1.2990 – 1.2995 to defend the barrier option. Institutional traders may also have an interest to take the knockout option out the market through a coordinated action.

The barrier option holder determines the day the option will expire but not the time. Barrier options expire at 15:00 GMT every trading day. The expiry time (15:00 GMT) is known as the New York (NY) cut. Institutional traders know the barrier options that are due to expire, the size of the option and its price levels.

The hunt for barrier options therefore occurs on a daily basis. The size of the barrier options may be as little as USD 150 million or over USD 1.0 billion.

Stop Hunt Caught in the Act

We would like to present you an event that took place several days ago on 5 March, 2015 at 22:00 GMT in GBPUSD.

GBPUSD 5min Chart

Please click on the chart to enlarge:

GBPUSD 5 minutes chart, 06/03/15

GBPUSD 5 minutes chart, 06/03/15

A barrier option was located at 1.5200. Due to thin market conditions as we explained earlier it is “easier” to shift the price higher or lower. At 22:00 GMT GBPUSD instantly dropped +41 pips to drive the price below 1.5200 and immediately rebounded. This was a coordinated action.

To provide a real-time example (at the time of this writing), stops appear to be concentrated at 129.20 in EURJPY. The reason why traders placed those stops at 129.20 is because the pair has reached a potential support level and could very well form a double-bottom reversal pattern.

EURJPY Daily Chart

Please click on the chart to enlarge:

Stops are located at 129.20

EURJPY daily chart, 10/03/15

We assume many technical traders noticed the pattern and decided to long the pair, layering their stops below the daily low.

We have spotted the pattern as well but due to the significant size of the stops we are aware it may attract key market players and refrain form issuing a long EURJPY trade alert. Regardless how the trend will develop in EURJPY this is just some of the precautionary steps we are taking when we issue our forex signals.

To summarize, there are constant intraday wars amongst institutional traders where retail traders are caught in between. Despite knowing the behind-the-scenes of the Forex market we do not suggest refraining from placing stops and entry orders.

We are suggesting to enhance your technical strategy for placing stops in the market. If you have been randomly placing stops in the market without a technical or fundamental reason it may be a great time to adopt a strategy.

You may review our stop loss strategies to understand what calculations are made when it comes to placing a stop loss order in the market. The alternative to stop loss orders is hedging but its complexity is not designed for the average forex trader.

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