How banks manipulate the market and hunt stop losses
Market manipulation is an intentional distortion of price action to trick market participants through either illegal or unethical means.
A definition of what is meant by "market manipulation" may not be enough to answer the question you are probably wondering about:
How and why is the market manipulated?
Before we get into this, you need to understand what a market manipulation zone is.
By definition, a manipulation zone is simply an area where the market has been manipulated and has eliminated some traders.
For example, when traders spot a potential double top like this:
They usually like to place a sell order at the resistance level and their stop loss just above it:
Then, the market hits your stop loss and almost immediately after that it reverses in the desired direction.
This zone is known as the manipulation zone.
How and why is the market manipulated?
First of all, retail traders don't have a major impact on price movements. However, those with deep pockets, such as banks, do. They are the ones who move and manipulate price action.
Market manipulation is due to the need to find liquidity in the market. For example, a bank wants to buy £600 million worth of stock, but it cannot be executed immediately because there are not enough sellers. It would surely incur losses if it simply executed the order like any other retail trader, buying directly from the market (because it would take multiple price levels to do so).
What these big market players tend to do is induce some downward pressure on the market by using part of their investment fund, say £40 million. Consequently, this creates a bearish sentiment in the market, which prompts traders to take short positions. So they can then enter at a lower price. When the price hits the desired targets, they put the rest of their £560 million into the stocks they intend to buy.
This will trigger stop losses on short positions and fuel the market's bullish momentum. Having clarified all of this, let's now discuss the various tactics used by these deep pockets to manipulate prices.
In this section, we explore the half-dozen types of market manipulation that can negatively affect you.
1. Market rumours and fake news
One of the most well-known forms of market manipulation is... rumors! Insiders spread false information, tricking a majority of traders into making trading decisions that they know are bad.
Some big traders or investors emit false information to drive a stock price up or down. For example, rumours intended to make inactive, dead companies look like great buying opportunities and drive up prices.
It's usually hard to make a reputable company look genuinely terrible in order to drag the price down, but that doesn't mean it doesn't happen. In general, rumours or fake news can greatly affect prices and are a major inconvenience for short-term traders.
How can I avoid being tricked by fake market rumours?
- Check the source: conduct extra research on your own to verify that the info being released comes from a legitimate source.
- Crossfade the initial movement. This is to trade in the opposite direction after the transmission of the suspicious news.
In other words, buy the rumour and sell the news.
Note: you need to be a market expert to be able to notice the fading of the initial move.
2. Pump and Dump
As with buying the rumour and selling the news, another market manipulation strategy is "Pump and Dump".
Pump and Dump is done via email or spam, as well as groups and seminars.
The "pump" is when the masses of retail investors buy stocks. This has the effect of driving up the price and volume of the stock even further.
As soon as retail investors commit to buying shares, the bad guys "dump" theirs, causing the price to fall.
It is usually easy for these players to manipulate stocks with low volume or volatility. From the information provided above, you can deduce that it is not a good idea to buy stocks with low volume or low volatility. The best way to avoid this type of manipulation is to avoid new stocks that suddenly spike.
3. Identity theft, or "spoofing"
Identity theft (also known as spoofing) is another manipulation tactic used by sophisticated short-term traders to manipulate the market. This is how it works:
The culprits place large orders at a particular level with no intention of executing them. Their systematic trading mode (via algorithms or bots) gives them the ability to create a large number of transactions.
Therefore, when other traders see large pending orders, believing that some major players want to buy or sell at a particular level, they'll want to trade in the same direction, and will therefore place their trades at the same level. But, a few moments before the market trades at its price, the algorithm cancels the orders before they can be filled. This swift technique allows manipulators to take control of the market in the short term.
After the manipulator withdraws the order, the market goes up or down, leading to losses for anyone unlucky enough to be tricked into buying or selling. The best way to avoid getting trapped, like many others, is to avoid very short-term trades.
If you want to trade in the short term and take advantage of this spoofing activity, you need to be a sophisticated and experienced trader with the right infrastructure to compete (special trading platforms). However, we advise you not to trade in the short term, stay away from this dangerous nonsense!
4. Bear raids
Bear Raiding is a manipulation technique used by players with deep pockets to drive down the price of stocks by placing large sell orders, after which the manipulator spreads misinformation within the market.
As other people sell, the drop in price allows the manipulator to take advantage of other people's losses. Bear raids can last for days, weeks, or even months. It has a harsher effect on long-term traders.
5. Wash Trading
Wash trading is when traders buy and sell orders that oppose each other. Wash trading doesn't generate any profits for the manipulators, nor losses. This technique simply intends to increase the volume of transactions in order to make a stock or any other financial instrument appear more active than it usually is.
Traders who notice price volume will be tempted to invest due to increased trading action. Wash trading affects short-term traders such as scalpers and day traders, and doesn't usually affect long-term investors or traders, as it doesn't last long. As wash trading doesn't have a lasting effect, long-term investing is the best way to avoid it.
6. Market takeovers
Market takeovers occurs when an individual, organisation or group of people attempts to gain majority control of an asset or stock in order to direct or dictate its price.
It takes a lot of time to achieve this sort of manipulation, which therefore has a negative effect on long-term investors. To avoid getting tricked, you should do thorough research on any financial instrument you're considering.
Other types of manipulation
Insider trading is when a person who has knowledge of key information about a company's financial performance before it is disclosed to the public trades in order to make a profit when the news goes public.
Churning is when fund managers or brokers responsible for managing large sums engage in excessive trading - which doesn't benefit their clients - in order to increase their brokerage commissions. This form of manipulation doesn't necessarily harm the general market, but it does harm individual investors.
When the market is manipulated, it creates an unfair environment for investors and can destabilise trading if it persists. This results in harm to traders like you who are unaware of market threats like these.
What is stop hunting?
Another sort of manipulation is stop chasing. This occurs when large market manipulators target stop loss orders near a certain specific level to satisfy their own liquidity needs.
While the market manipulation tactics we covered earlier can play a key role in fundamental analysis, stop hunting plays a key role in technical analysis.
How can I avoid being hunted?
Quite honestly, there's no way you can completely avoid being chased, but there are ways to minimise the chances of getting hit.
And the main technique is to strategically set your stop loss. Don't set your stop loss right above a major resistance level or below a major support level. Since liquidity is above the resistance and below the support, the price tends to move from one point of liquidity to another and this is where most traders place their stop losses.
Note: stop loss = Liquidity
The next question now is: where should you place your stop loss?
The anwser is: a reasonable distance from the support or resistance level. You can use the Fibonacci retracement tool to help you measure your stop loss.
Another important point is to set your stop loss at a level where your trade is no longer valid. In general, many trade entries are based on retracements, breakouts, and chart patterns. When trading a retracement, the general rule is that your stop loss should be below the previous low or above the previous high. And with breakouts, the general rule is that your stop loss should be above or below the consolidation zone.
If your entries are based on chart patterns, then your stop loss should be placed where the chart pattern is no longer valid. Let's look at this breakout trade for example.
Note that there is a bearish engulfing candle that swept past the previous highs.
Do you see how the stop loss was placed above the range? This is a good example of how to set your stop loss.
Regardless of the size of your stop loss, what matters most is your position size, and you need to understand risk management before you start trading.
So, what strategy should you use to avoid stop hunting? Below, we'll discuss a strategy that can help you avoid being victimised by stop hunting.
- When price approaches an important support or resistance level, the best thing to do is wait for a convincing reaction as to what price is likely to do.
- Let the price trade above previous highs or lows.
- Expect a rejection candle or an engulfing candle.
- And enter your trade accordingly.
The best brokers to trade currencies
FAQ
1. If I use a small position size to cover my stops, won't my profit also be small?
Yes, your profit will also be small. However, the upside to this is that your stop loss limit will be covered.
You need to understand that protecting your capital should be a top priority, because this is better than unnecessary losses due to poor risk management.
2. If I don't set a trigger level, will I become a victim of market manipulation?
In all probability, you won't be hurt by market manipulation if you don't set a loss threshold. However, you are still at risk of losing your entire trading account because the market might just reverse completely and never come back.
3. What kind of trader is likely to be a victim of stop-loss hunting or market manipulation?
Most market manipulations have negative effects on short-term traders. They are most sensitive to "fake news", "pump and dump" schemes, etc. So scalpers and day traders are the ones who get hurt the worst.
4. Do long term or swing traders also suffer from market manipulation?
Yes, but they're less subject to acts of market manipulation. They don't usually fall into these traps.
5. Does market manipulation occur across all time frames?
Yes, market manipulation can happen across any time frame. But the longer the time frame, the less you're exposed to manipulation. Also, your trading decisions will be better when you trade on higher time frames.