I've seen a lot of videos warning about putting the stop loss too tight because there are stop loss hunters (usually big companies with a lot of money).
But I cannot understand how they do that. I mean, they need to move the price in some desired direction.
What are the techniques used for this? And also, are they legal?
This is best worked through with an example:
Suppose you own 100 shares of ABC co., which you bought today for $900, at $9 each. If you set your stop-loss at $8.1, then a 10% drop in price would force the sale of your shares. If there is low liquidity in ABC Co's shares , then one sufficiently motivated individual could sell enough of their own shares to drop the price, triggering your stop loss order, therefore bringing your shares on the market for a much lower price.
Now let's say there are 500 buy orders listed at $9, and 100 shares are selling at $8.5. If someone wants to 'hunt for stop loss orders', then they could (1) sell 500 of their shares at $9, and (2) 100 shares at $8.5 [this clears the open order book of buy orders]. If we assume the 'real value' of the shares is $9, then doing this only costs the person 100 shares * (9-8.5) = $50.
After selling into the last open 'buy order', the same individual could then (3) put in sell order for, say, $1, and perhaps they would even use another account to put in a mirror order to buy for $1. This sets the new market price at $1. Suddenly (5) your stop-loss triggers, and your shares get listed on the market. The nefarious individual can now (6) put in an order to buy 1,000 shares for $5 each, and in the process scoop up your shares on the cheap (and anyone else who happened to have a stop loss order), and if the true value of the shares is still $9, then they could immediately sell them for proper value, once there is additional liquidity in the market.
Now of course, the example above is quite far-fetched, because it relies on effectively a 0 liquidity stock. This extreme example is done just to highlight the point; the same process could occur with a share trading between $100 and $99, but the gain to the manipulator would then be <1%, instead of >40%. The more liquid the market, the less someone would be able to move the price, and the more expensive it would be to do so (because they would need to eat more orders to buy at decreasing prices, thereby selling more of their own stock at a loss).
There are other similar events possible to be triggered. For example let's assume you have your orders on a margin account with a broker. That means effectively that you borrow money from your broker to invest, with some initial money of your own, and your shares are held by the broker as collateral. In that case, the broker can have the option of selling your shares once the net value of your collateral reaches $0. In such a case, using the example above, if your broker were the one to manipulate the market, then they could more easily achieve the above, because you don't even need to have a stop-loss order in place yourself - your own margin will be 'called' once your share value equals your loan from the broker.
In a modern regulated market, such price manipulation is going to be considered illegal, though it may be hard to detect. In a stock with healthier liquidity (ie: not a penny stock, which might go days without trades occurring), the danger is also lower, as mentioned above. If you trade in something like cryptocurrency, which is unregulated + has many effectively 0 liquidity trading pairs, then something like the above can and does happen regularly.
Stops trigger for a couple of reasons. First and foremost is that they are placed too close to the market and they trigger because of the trading range of the stock.
Another reason for a stop being triggered is when there is pending news. Traders pull their orders and market makers widen the B/A spread to protect themselves because of low liquidity during the waiting period prior to the news. The result is that spreads widen.
I don't believe that anyone is hunting stops in large cap stocks. The volume needed to move price is too large and there's no guarantee that price won't reverse and result in a bear trap.
For illiquid stocks, it's a different story because it doesn't take much volume to move price. If you're going to play with illiquid stocks, be prepared for volatility. And, they're not good for trading.
AFAIC, you should set your stop loss at a level at a price which executes at your maximum acceptable loss. You made a bet. You were wrong. Book the loss. Move on. Stop loss hunting conspiracies are usually the purview of web sites selling advice.
