Percentage Stop Losses Trigger High Frequency Traders

Differences in Uptrend and Downtrend Trading

The Uptrend and the Downtrend are not mirror images of each other, nor can you use the exact same indicators, indicator period settings, or subordinate indicators. The Downtrend can drop and gap down on low Volume because percentage stop losses trigger High Frequency Traders.

Many Retail Traders assume that if they learn the upside price action, that when the trend turns down, it is just the opposite price action. That is why so many Retail Traders struggle to exit stocks before the trend tops and runs down. In addition it is why many Retail Traders who try to Sell Short as well as Options Traders who buy Puts, take so many losses in their trading.

If you are a Position Trader, you will be trading the Uptrend and the Sideways Trend. If you are a Swing Trader, you must trade the Uptrend and the Downtrend, and adapt for the Sideways Trend. Swing Traders must be able to take advantage of both the upside and downside price action, in order to net profits that are close to what a Position Trader can achieve. However, the Position Trader will generally always have far higher returns.

The Sell Side or Downtrend, is very different from the Uptrend and the Sideways Trend, because there are fewer Market Participant Groups. Giant Buy Side Institutions who invest in Mutual and Pension Funds do not Sell Short.

They may buy Option Puts or Ultra Bear Exchange Traded Funds as a hedging or mitigating strategy when the market goes down, because they are longer-term investors. Smaller Lot Investors, Corporations, Billionaires, other wealthy Individuals, and Foreign Funds also do not Sell Short.

High Frequency Trading Firms, Professional Traders, and some Retail Traders do Sell Short or use Options to make profits during a Downtrend. This is why the Downtrend is so very different than the Uptrend and the Sideways Trend. The Downtrend often has much steeper Angles of Descent™ immediately causing a severe drop in price, and there are often gaps as High Frequency Traders trigger on news events. The Downtrend also has larger rebounds as it bounces off of support. How fast the price will fall is dependent on many factors, but the most important is always the number of High Frequency Traders that trigger the sell-off.

The Downtrend can drop on low Volume, and can at times gap down through technical support levels. This is due to how and where Retail Traders and Smaller Funds set their stop losses. Percentage stop losses trigger High Frequency Traders, and using them is a common mistake that many Retail Traders make. Often everyone in these groups uses the same percentage stop loss, therefore many strategies are used by High Frequency Traders and other Professional Traders that cause these percentage stop losses to trigger.

When this happens the stock usually hits the stop loss, then rebounds back up. Percentage stop losses trigger High Frequency Traders and other algorithms search for orders that are clustered around a percentage, which is called the “Cluster Order Syndrome.” As the stock drops, the stop losses trigger and the stock plummets. The chart example below shows how a 10% stop loss triggered a huge down day.

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Martha Stokes CMT

TechniTrader technical analysis using a MetaStock chart, courtesy of Innovative Market Analysis, LLC dba MetaStock

Chartered Market Technician
Instructor & Developer of TechniTrader Stock & Option Courses

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