Have You Ever Had Your Stop Loss Hit, and the Stock Bounced Back Right After?

This is a common experience for many traders and is often referred to as "stop loss hunting." Now let’s explore what stop loss hunting is, why it happens, and how you can avoid it. If you're new here, you can always consider this place for the latest market updates and valuable insights.

What is Stop Loss Hunting?

In the stock market, big institutional players, often called stock operators, can be seen as hunters, while retail traders like us are the prey. These big institutions target the stop losses (SL) of retail traders to make profits. It’s like a jungle out there where the hunters aim to "hunt" the stop losses and take advantage of the situation.

How Does Stop Loss Hunting Work?

Imagine a stock is trading at a certain support level. Retail traders set their stop losses just below this support. The market might suddenly crash, hitting these stop losses before bouncing back up. This rapid fall and recovery can be seen as a shadow on the chart, indicating that many stop losses were hit. This shadow forms at the bottom, showing that the big players have triggered many stop losses.

For instance, if a stock has a psychological stop loss level at ₹98 while trading at ₹100, big players might sell aggressively to push the price down. This triggers the stop losses set by retail traders, causing the price to fall further as new traders see the breakdown and create short positions. Once enough stop losses are hit and the selling pressure increases, these big institutions start buying the stock at the lower price, driving it back up.

Example and Charts

Below are the attached charts of Tata Motors, where stop loss hunting can be seen very clearly. Notice how the price broke the support and the very next candle bounced, causing the stock to boom.

For a better understanding of this whole process, you can refer to the attached video.

Why Do Institutions Hunt Stop Losses?

Generating Liquidity

When liquidity is low, institutions hunt stop losses to create more buying opportunities. By pushing the price down and triggering stop losses, they increase the number of sellers, which allows them to buy large quantities at a lower price.

Buying at a Better Price

Institutions prefer to buy at lower prices to improve their average purchase cost. For example, buying a stock at ₹98 instead of ₹100 makes a significant difference when dealing with large orders worth crores of rupees. By hunting stop losses, they can purchase substantial amounts at a cheaper rate.

How Do Institutions Know Where Your Stop Loss Is?

Support and resistance levels are common knowledge among traders. Most retail traders place their stop losses around these psychological levels. Institutions exploit this by targeting these areas, knowing that a large number of stop losses will be triggered.

How to Avoid Stop Loss Hunting

While you can't prevent institutions from engaging in stop loss hunting, you can adjust your strategy to minimize its impact:

Use a 5-Minute Chart

When you suspect a stop loss hunt, check the 5-minute chart. If the market breaks down and there is no significant sell signal within the next five minutes, it might just be a temporary panic. Hold your position and wait to see if the market stabilizes or turns sideways.

Avoid Setting Obvious Stop Losses

Instead of placing your stop losses at common psychological levels, consider setting them at less obvious points. This can reduce the likelihood of your stop loss being targeted by institutional players.

Stay Informed and Patient

Always stay informed about market conditions and be patient. Don't react hastily to sudden price movements. Analyzing the situation calmly can help you avoid falling prey to stop loss hunting.