Liquidity Hunting or Stop Hunting in Trading
In this article, I will discuss What is Liquidity Hunting or Stop Hunting in Trading with Real-time Examples. Please read our previous article discussing the Breaker Block Trading Strategy with Examples.
What is Liquidity Hunting or Stop Hunting in Trading?
Liquidity Hunting or Stop Hunting is when the price will move just above or below an area where retailer’s stop loss orders are placed. Executing those orders and reversing.
How do they do Liquidity hunting or Stop Hunting in Trading?
Let us discuss this with an example. Price in downtrend and retracement is going on. You SELL by seeing bearish engulfing after retracement in a downtrend because that is the logical thing to do. The location you sold at was the correct thing to do, and if the price went down and you made money.
And then what happens is suddenly, the price moves up to the stop loss level, hits your stop loss, and takes you out of the trade. You think to yourself, “Well, maybe I just made the wrong trade.”
And then what happens if the price goes down, and after taking your stop loss? This means that all those stop orders and buy stops provided enough liquidity for the smart money to sell without incurring any slippage.
The objective of Liquidity hunting or Stop Hunting in Trading
Smart money before taking liquidity. They Build up Liquidity. Why are they doing this? They build their future Targets without any slippage and buy discounts and sell premiums.
Smart money only targets locations with higher Volumes pending, and he collects them by inducing traders to buy/sell in the wrong direction and trap them and stop them. So the main objectives of Liquidity hunting or Stop Hunting are as follows:
- Avoid Slippage due to big orders. Stop hunts are a crucial mechanism for Institutions to be able to conduct large transactions without “slippage.”
- Buy low(discounts), sell high (premium)
Types of Liquidity Hunting or Stop Hunting in Trading
Smart money uses two mechanisms for liquidity collection
- Inducement in the wrong direction
- Stop hunting in the wrong location
Stop Hunting in the wrong location
This means after your stop hunting price moves in your original direction. Premature entry induces traders to take positions in the wrong location. Create panic by moving against your entry. Hit the stop Losses, grab the liquidity.
Let us give an example. The natural thing to do is to SELL when you witness a double top after a pullback in a downward trend. The location where you sold was “correct,” the price dropped, and you made some money.
Suddenly, the price rallies to your stop loss level, hits your stop loss and takes you out of the trade. You think to yourself, “Well, maybe I just made the wrong trade.” And then the price goes down, and after taking your stop loss. This means that all those stop orders and buy stops provided enough liquidity for the smart money to sell without incurring any slippage.
Let us give an example. In the below picture, the Price took bullish momentum before reaching the demand zone. The natural thing to do is to buy the demand zone and sell at the supply zone. but the location where you sold was “incorrect.” it creates FOMO ENTRY for early buyers. You buy and put a stop loss below the demand zone.
The price falls to your stop loss level, hits your stop loss, and takes you out of the trade. You think to yourself, “Well, maybe I just made the wrong trade.” And then what happened is the price moved up after taking your stop loss. This means that all those stop orders and buy stops provided enough liquidity for the smart money to buy without incurring any extra slippage.
Inducement in the wrong direction
- Induces traders to take positions in the wrong direction. Fomo Entry
- Create panic by moving against her entry
- Hit the stop Losses, grab the liquidity
Induce traders to take positions by proving that the price will move in a certain direction. An inducement is a form of liquidity found near the Area of interest or supply-demand zones, which is basically seen as a trap for retail traders.
Below is an example of an inducement
How do we know where the liquidity is in the chart?
Smart money only targets locations with higher Volumes pending, and he collects them by inducing traders to buy/sell in the wrong direction and trap them and stop them. Once you can identify where volumes are, you have identified where the smart money trades from, and you trade with them.
Liquidity-hunting locations are like
- support and resistance, or supply demand zone or order block zone
- the area on consolidation/accumulation
- double top, double bottom, and
- Trendlines. Or chart pattern
- Previous day high low
- Session high low (The beginning of the day)
- At the end of the day
These areas are mostly generating liquidity in the markets. We expect the price to be manipulated around these locations. Range /consolidation /any support resistance zone
- Range traders who have taken short positions at the top of the range will have a stop loss above the range. Therefore, the initial breakout will hit all stop-loss buy orders.
- The breakout movement will begin to induce traders to take long positions as breakout trading.
- Induce to take long entry at the test of the flip support zone
- Once the price sustains beyond the flip zone again, new long entry
- All of these entries become liquidity for smart money
- Once the required liquidly collected by smart money, they reverse the direction
Double Top, Double Bottom
From the mindset of retailer’s trader. We buy the double bottom and sell the double top. Smart money is aware of this. They can see that stop-loss orders are building up there in large numbers. The primary responsibility of institutional traders is to sell the shares they currently hold. They want to buy low and sell high without any slippage.
Trendline and Pattern
Below is the bullish order block with trendline liquidity hunting
Session Liquidity in Trading
Let me see you first the volume curve of intraday trading
Session high and low act as lie liquidity because most traders stop loss orders above high or below low.
Liquidity Hunting or Stop Hunting in Trading Summary:
Liquidity hunting, often called stop hunting, is a market phenomenon that can occur when there’s visibility or predictability of a large concentration of stop-loss orders. Institutional traders, market makers, or large individual traders with significant capital (“whales”) may be able to move the market with sizable orders. They may “hunt” these stop-loss levels to trigger a price movement that benefits their trading positions.
Here’s how it typically works and what traders can do to avoid being caught in such situations:
How Liquidity Hunting Works in Trading?
- Identification of Stops: Large traders identify where a significant number of stop-loss orders are placed, usually around key technical levels such as support, resistance, round numbers, etc.
- Initiating a Push: These traders may then initiate a push towards these levels by placing large orders.
- Triggering Stops: As these levels are hit, the stop-loss orders are triggered, resulting in a sudden influx of buy or sell orders, which can push the market further in that direction.
- Taking Advantage: The large traders may take positions opposite the stop orders, benefiting from the resulting price movement.
How Traders Can Avoid Stop Hunting in Trading?
- Wider Stop Losses: Place stop-loss orders at less obvious levels, a bit further from the common support and resistance levels, to avoid being easily targeted.
- Use of Hidden Stops: Some trading platforms offer the option to place “hidden” stop orders that are not visible to the market.
- Mental Stops: Use a mental stop instead of a hard stop. This requires discipline to execute the trade as if it were a real stop-loss order.
- Time-Based Exits: Instead of stop-losses, consider exiting trades based on other criteria such as time (e.g., end of the trading session or upon certain news events).
- Avoiding Overleveraging: Trade with sufficient capital and avoid overleveraging, which can lead to tighter stops that are more easily hunted.
- Understanding Market Behavior: Be aware of times when stop hunting is more likely to occur, such as during low-volume periods or just before/after significant news events.
- Price Action Confirmation: Wait for price action confirmation before entering a trade, which might mean missing the very start of the move but could prevent entering right before a stop run.
Absolutely; here are some important considerations regarding liquidity hunting and stop hunting:
- Psychological Levels: Traders often place stop-loss orders around round numbers or historical support and resistance levels. Being aware of these can help in predicting where liquidity hunts might occur.
- Market Conditions: Thinly traded markets or times when trading volumes are low (like just before market close, around major holidays, or during unexpected global events) can be more prone to liquidity runs due to the reduced number of orders in the market.
- High-Impact News Events: Economic announcements or geopolitical events can create volatile market conditions where liquidity hunts are more likely. Traders may pull their stop orders ahead of such events to avoid getting caught.
- Algorithmic Trading: Many trading algorithms are designed to detect clusters of stop-loss orders, which can exacerbate the speed and intensity of a liquidity hunt.
- Managing Risk: Understanding that stop hunting is a part of trading, traders should always have a risk management strategy that accounts for the possibility of such events.
- Not a Guaranteed Event: It’s essential to note that not every sudden move is a result of stop hunting. Markets can move quickly for various reasons, including genuine changes in market sentiment or large orders from institutional investors not intending to hunt stops.
- Regulatory Perspective: While liquidity hunting is not illegal, it does walk a fine line, and there is a constant debate about the ethics of such practices. Regulatory bodies may investigate unusual market movements, especially if there’s evidence of market manipulation.
Understanding these considerations can help create a more robust trading strategy that can withstand the tests of different market conditions, including the possibility of liquidity or stop hunting. It’s all about managing risk and being aware that the markets can be unpredictable and, at times, hostile to retail traders.
In the next article, I will discuss the Sniper Order Block Entry Trading Strategy. Here, in this article, I try to explain Liquidity Hunting and Stop Hunting in Trading with Real-time Examples. I hope you enjoy this Liquidity Hunting and Stop Hunting in the Trading article. Please join my Telegram Channel and YouTube Channel as well as my Facebook Group to learn more and clear your doubts.
About the Author: Pranaya Rout
Pranaya Rout has published more than 3,000 articles in his 11-year career. Pranaya Rout has very good experience with Microsoft Technologies, Including C#, VB, ASP.NET MVC, ASP.NET Web API, EF, EF Core, ADO.NET, LINQ, SQL Server, MYSQL, Oracle, ASP.NET Core, Cloud Computing, Microservices, Design Patterns and still learning new technologies.