Being the most volatile and leveraged marketplace Foreign exchange market is the favorite trading venue for both retail and institutional players. Alike from the equities market where the available leverage usually provided by the brokers between the range of 2:1 to 3:1 where a trader have to put a larger amount of equity to control a long exposure and it also limits the trader to handle a huge position, but in forex market the leverage can be as high as 100:1 which means a trader can open a position worth $1000 by using only $10 as equity or initial investment. This high level of leverage gives a retail trader the power to participate in the market with huge exposure.
However this high level of leverage is a double sharp sward which can give a extraordinary profits or wipe out all your equity in a friction of second. High level of leverage in the Forex market and huge volumes of trades makes this market highly volatile and risky. The main reason behind the losses for the retail traders is the poor management of the available leverage as usually retail investors usually fails to control the exposure which results in a huge loss or even a loss of the whole investment in just one trade. In this article, you’ll learn how to manage your money and use stops to not only limit your losses but also to maximize your profits in the Forex market.
Others Loss is your Profit
A highly liquid and leveraged market like Forex market attracts a huge number of participants and most of the market players who participate in the Forex market understand the importance of stop loss levels or stops. To ensure the long-term trading success and survival every trader should learn to use the stops in order to prevent huge losses and make money out of the market. Trading without stops is like fighting a battle with your own as it can only gives you huge losses as a large number of Forex market players are speculators not investors, therefore, they cannot hold a losing trade for too long because of margin requirement due to increasing losses which can overtake the entire investment if the positions are highly leveraged.
Because of this necessity of stops in the Forex market few big players and smart traders made a strategy to encash this opportunity created by the human emotions and decision paralysis. The strategy to make money from others stops is termed as stop hunting. Stop hunting is a very common and widely used trading strategy in the Forex market where traders and speculators place there strategically positions by analyzing the stops of other traders in order to make money from the panic selling momentum in the market. Stop hunting is nothing more than a strategy with focuses on flushing out all the losing players from the market.
Human mind and psychology plays a huge role in the trading business, human mind always craves for simple and easy looking round numbers thus most of the stops and targets are usually fall in the “00” space or in round numbers, For example, if a trader is in a long position in GBP/USD then he looks for the round number to enter and exit from the market because of the human mind which naturally seeks round numbers. As most of the retail traders place their stops at crowded and more usual locations big institutions like banks and hedge funds place their positions strategically against those stops and hunts profits out of it.
How to take Advantage of the Hunt
Stop hunting with the big player is not an rocket since, any trader can master Stop hunting with constant practice and knowledge. With the help of a normal price chart and a simple moving average indicator anyone can master the art of stop hunting. A simple and easy explanation of a stop hunting strategy is to place a order close to the round numbers for example if you want to trade the pair USD/JPY and you thinks that the price will go down from the current levels then the first process to make the stop hunting successful is to determine the major direction of the pair by taking help from the long term moving average like a 100 days moving average. After determining the major direction of the pair you need to place a short order after the nearest psychological level for example if the USD/JPY is approaching 113.00 levels then you can place a short trade at 113.15 levels and keep the first target at 113.00 and second target at 112.85 levels by keeping a stop loss at 113.30 levels which is in this case 15 pip higher from the entry point.
As the stop hunting is purely a momentum based strategy a trader must watch the market constantly and monitor the price movements. In the absence of an increased volatility a trader should not hold the stop hunting position and close the trade as without momentum this strategy cannot work. The mechanism behind the stop hunting is to take advantage of the increased level of speculations occurs in the market when the price reaches a round psychological level. The other rule to consider when trading according to the stop hunting strategy is to always follow the major trend or the dominant movement in the market. A simple moving average can help a trader to understand the major trend in the market and help him in implementing a successful stop hunting strategy.
Let’s take a look at a short trade to understand the short hunting with a real life example.
Note that in this example, The GBP/USD is trading well below its 100 SMA, indicating that the pair is in a downtrend. As prices crosses the psychological level of 1.2900 levels , the short hunting trader would initiate a short the moment price crosses the 1.2915 level, putting a stop 15 points above the execution level which is at 1.2930. In this example, the downward momentum is very strong as traders got stopped out at the level of 1.2900 very quickly. The first target of the trade is done at 1.2900 levels for a 15-point profit and the second and final target is exited at 1.2885 generating 45 points of reward for only 30 points of risk involved in the trade.
Leverage is the key:
Forex is a highly rewarding market for day traders and a stop hunter can earn enormous amount of money by trading in the forex market as most of forex brokers gives traders a massive amount of leverage to trade in the Forex market. A trader can enter in big trades with a very small amount of investment with the help of high level of leverage Forex brokers provide to the traders. This huge amount of leverage is a very tough thing to manage as a misuse of it can lead to huge losses even traders can lose their whole investment capital in only one wrong decision.
Because of this managing, the level of leverage according to the risk-taking capacity is very important in Forex market not only to prevent huge losses but also to optimize the available leverage efficiently to make money out of the market.
A risk is a stubborn part of every trade and to avoid the huge amount of risk associated in the forex market traders widely use stops to avoid any big losses, risk always come hand in hand with the level of reward you can make out of a trade. Knowing, and managing risk with the use of stops is the most curtail part of trading in forex market as this will decide whether you can make money out of the market or the market will take all your equity and make your account zero. Overlooking risk can result in a heavy loss and even nullifying your profits and it can also eat up your investments.
However, these stops gives other big market players an opportunity to make money, and even a retail trader can be a part of this hunting by understanding the market dynamics and human behavior easily with a disciplined approach and with the help of fundamental and technical analysis and basic behavioral knowledge, anyone can be a part of stop hunting and earn a lot of money in a momentum based trading which stop hunting gives to a trader. Good trading habits, a well-researched risk and reward strategy and optimum utilization of leverage and liquidity with a keen understanding of human behavior and market movement can result in highly successful and profitable Forex trading business by generating good returns with minimum possible risk.