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I have read many stock related forums over the years. One thing I have seen many people say is that they refuse to use stop orders because they don't want the market makers to "take out their stop". There seems to be a widespread belief that because stop orders go to the exchange, the market makers can see everyone's stop orders, and they will sometimes manipulate a stock's price to trigger a large amount of stop orders and obtain people's shares. Quite a few people have lamented that their stop order was triggered at the exact low of a move, and then the stock immediately started moving up again without them.

My question is do market makers really try to trigger people's stop orders? If so, how does that benefit them, and is that type of price manipulation even allowed?

4 Answers 4

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I think that the theory that market makers take out stops in order to screw people is an excuse that people make for placing a stop order that gets executed. The fact that it occurred at the exact low of a move, and then the stock immediately started moving up again without them is a function of the order being placed at that price level and then the security reaching that price and then coincidentally reversing.

The market is an auction. In the absence of liquidity, the market maker makes the market and he is the bid and the ask price. Anyone who comes in with an order with price movement (higher bid or lower ask) then becomes the market on that side.

If the security is liquid, there may be hundreds or even thousands of of orders on the order book in close proximity to current price - and each order may be for 100's or 1,000s of shares.

So riddle me this. You place a stop order $2 below current price and suppose that there are 50,000 shares on the order book between current price and your stop which is $2 lower. Do you really believe that the market maker is going to sell 50,000 shares to drive price down $2 so that he can pick off your stop and then reverse the market? All because of you??? And that 50,000 share number doesn't include the 100s (or more) of buy orders that come in as XYZ drops $2. This conspiracy theory defies logic.

Narrow stops get hit frequently. Wider stops do not and sometimes, the stock just drops to where the stop was placed.

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  • In the example that you provided, if there's only one stop for say 10 shares at $2 below current price, then sure it wouldn't really make sense to try to take out that one stop. But what if there's a price that's viewed as a critical support level and thousands of traders have placed stops just below that level, adding up to millions of shares? Would a market maker have any incentive to try to take out all those stops?
    – 7529
    Apr 15, 2020 at 23:22
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    If you trade stocks that are that illiquid, you can expect erratic price movement. In reality, your example is a unicorn. If there's one order for 10 shares below current price, it's nonsensical to place a stop order, let alone own that stock unless it's to OWN that stock. I know a guy online who buys such stocks that rarely trade at all but he's in for the long haul, regardless of price. Stocks that trade by appointment are not for trading. Apr 15, 2020 at 23:44
  • What about my example of a liquid stock that has thousands of stop orders representing millions of shares underneath a well-known support level? Would a market maker have any incentive to take out those stops if the current price is not far from that support level?
    – 7529
    Apr 16, 2020 at 2:09
  • Let's assume that the stops placed are not narrow because they would be easily triggered by random intraday fluctuations. So if there's a price some distance away that's viewed as critical support level and thousands of traders have placed stops just below that level, adding up to millions of shares, don't you think that there are 1,000's of orders adding up to millions of shares that are between current price that magical support level that everyone somehow perceives? It's not a logical conclusion that the market maker has the wherewithal or inclination to suck up such volume. Apr 16, 2020 at 2:22
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Most exchanges do not directly support stop orders, and even if they did, exchanges would not disclose these orders in their market data feed until they had been activated (i.e. the stop price had been met).

Brokers generally simulate these orders by subscribing to the market data feed, and having their order routing system send the order when the stop price was reached.

There is an illegal practice called frontrunning where market participants try to get information about orders coming into the market before they arrive in the market (allowing them to move their prices in the opposite direction before they arrive). This gets detected and firms involved in it get fined and shutdown.

As far as a market maker moving a price up and down. They are allowed to bid or ask whatever their price they choose, so might try to widen their spreads and move the price up or down to flush out any stop orders. This would be easier for them to do in an illiquid stock rather than a liquid one (where the market maker might be a minority). I am not sure this is inherently wrong, though there are rules against market manipulation. The market maker has to be able to make money somehow (otherwise, who would be willing to make markets).

If one thinks the market maker (or another market maker) behaved improperly, one can raise a complaint to their broker, broker's regulator, exchange, and or the securities and exchange commission. However it is likely that the market maker did nothing wrong.

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Market-makers are looking at a depth-of-market chart and they do game-the-market as that is a model of human behavior. Basically, the trader needs either a strategy of tight stops or a strategy of wide stops.

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There's another way to look at this: what are the objectives and methods of market-moving participants?

Imagine you need to move 1 million shares today in a security that typically trades 20 million shares per day -- you're a big trader. Our question is: do your methods likely include "stop hunting"?

What needs to happen?

  • You'll probably harm your profitability and market orderliness if you put in very large quantity orders.
  • You also want a good price, so ideally the market will temporarily dislocate, allowing you to open or close more profitably.
  • You need counterparties to absorb the other side of your trades -- so you need to find liquidity.
  • You probably need to adhere to limits of risk and capital deployment
  • If you are also a designated market maker in this security, you need to continue to adhere to exchange rules around providing public two-sided quotes, fair executions, etc.

How could this be achieved?

  • If you were selling to close, you'd benefit from the market price dislocating up, finding enough buy interest to satisfy and then the market continuing onward.
  • You might benefit from multiple cycles of this and possibly at different scales and timeframes: you plan to work your order in pieces, and by definition realized volatility will be decreasing the longer the market stays around a price level (even if it is a more advantageous level to your objectives than the previous market level) -- and with it you expect order flow could decrease if the price doesn't move substantially again (experience shows a correlation tends to exist between realized price volatility and order volume)

What could create those conditions?

  • Price movement could increase the buy order flow (following the tendency for order flow to increase when volatility increases). So you might want the kind of price volatility that will bring in buy orders.
  • Logically, orders are intended either to increase gains or to reduce losses. Buyers opening positions (looking for an "up move") may be motivated by a modest price decrease (too much otherwise "favorable" movement and their outlook may change), and buyers closing positions (perhaps effectively protecting against a "down move") may be motivated by a price increase (eg, stop losses). Realistically, you may need to trade substantially with both "types" to get your job done.

What happens to create the price volatility that encourages buy orders to arrive?

  • This can be left to one's imagination.
  • Note that we're interested in buy orders we can execute against under our objectives above: both "buy to open" and "buy to close" orders, stop or limit, at-rest or transient, etc.

How does this relate to the order book?

  • I.e., can/should "big trader" use order books to determine buyer interest?
  • Do the major exchanges where the security trades offer detailed order information to customers, and did the trader buy those feeds?
  • Is there substantial volume off-exchange, and is the trader part of those quoting/matching pools? (They may provide only partially desired information such as limit orders only).
  • Also the composition of orders "away" from the current market tends to change substantially the more the market moves towards those price levels, so current BUY STOP orders resting, eg, 1% above the current best offer may be only a rough idea of the available orders when the market actually moves up 0.5% or 1% -- so the order book doesn't tell you what's actually available when the market arrives at that price level
  • one can obtain different information from submitting orders that execute than from looking at the resting orders, and so "big trader" behaves accordingly

Some questions

  • if you saw a large volume of BUY STOP orders on the books, would you trade accordingly? Would that make you a "stop hunter?"
  • if you don't have or observe order book data containing stops and you follow a trading pattern (perhaps from experience) that causes many stops to be executed, are you a "stop hunter?"
  • if you need to put on trades to discover prices regardless (since the resting order book does not indicate all possible order flow, just possible commitments at an instant in time), then order book information (whether containing stops or not) may be at best a general "indicator" and not a "plan of attack" (because orders constantly appear and evaporate)

To what extent are there concerted efforts to "stop hunt"?

  • Who knows? But there are probably major common motivations for order flow (eg, retail stop losses to preserve capital; institutions reducing risk per charter mandate or borrowing agreements). What do you care if your opposing buy orders are retail or otherwise, stop or limit?
  • Whether the casual observer calls it "manipulation" or "stop hunting" is secondary to the fact that you as "big trader" have a job to do. There's probably a general pattern of trading activity you'll follow to achieve this, and probably you can see it on the tape when it's done -- the main difference might just be how we label that pattern of market activity.

And what if you're the small trader instead?

  • You might expect certain patterns of market activity (eg, occasional price dislocations, "zig zag" price action, etc) by better understanding the objectives/parameters/limitations of "big trader"
  • You may or may not want to use stop orders (you may want to disincentivize "big trader" from believing there is a bigger gain to be had by approaching your stop, or you may realize that you need stops to satisfy your trading parameters)
  • Consider substituting your "worry" with analysis and action: what is the expected return if you hedge for volatility occasionally executing your stops at a loss? Can you manage capital differently so that you can tolerate a larger stop range?
  • "To know and to not act is to not know" - meaning if you "know" that market makers are stop hunting but not taking action on this belief (performing research, experimenting, position sizing, capital management, etc), one might argue that you don't really "know" whether stop hunting is happening at all and it's just a vague complaint occupying thought power without improving your decision-making and behavior. Consider whether history's legendary traders took an approach of "this isn't fair" versus "how can I do this better?"
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  • Not sure if answers may get a downvote when they land in the "late answers" queue like this one. Anyway, community is invited to confirm/clarify points or propose edits. Thanks! Mar 9, 2023 at 19:48

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