Where Large Traders Place their Stops

Note: a prior version of this article was produced for OrderFlowTrading.com

A good way to understand the importance of stop clusters and why they are positioned in certain places is to first review the concept of support and resistance.

Support and resistance are two very important concepts and you can build your entire trading career around these two concepts. Broadly speaking, a support is a level where the market previously showed demand; it's a level that propelled price higher.  Instead, a resistance is a level that has previously shown supply; it's a level that has propelled price lower. Professional traders day in & day out highlight supply & demand zones and then wait for certain characteristics in order to initiate a trade. 

There are always a great number of supply and demand zones on the charts, simply because the perception of value is constantly changing. 

Market participants are constantly trying to price in (or discount) what will happen tomorrow, next week, next month, next year (which are all uncertain) and thus create an expectancy. Thus something that is highly in demand today may be sold aggressively tomorrow or next week. Of course, as many other things with the markets, we should always look at the most evident supply and demand levels (i.e. Support and resistance levels). The more evident the level, the larger the imbalance was created and the more likely price is to find renewed support or resistance next time round.

Take note that support and resistance are not precise prices. They are “zones” 

that can extend 20-30 pips above and below the actual price level.

Source: FXCM Marketscope

Now, due to the fractal nature of the markets, these support and resistance zones are created on all time frames. It's up to the trader's own objectives and risk-tolerance to decide whether to use them on all time frames or whether to stick to a handful of chosen time frames. Obviously the higher the time frame, the more participants are active and see it. Therefore, the more weight that particular zone/level may have.

The fact is that evident price levels that have been rejected before are evident on the chart, because they usually show some sort of orderflow imbalance footprint: inside/outside candles, doji's, spinning bottoms/tops, etc. and price gets pushed aggressively away. When the market comes back to challenge that area, chances are that it will be a crossroads once again, where buyers and sellers will be fighting to estalish the upper hand. Who will win? We will never know ahead of time. The trend and the fundamental influences at the time can give us a hand but the fact is that:

you will never know ahead of time if a previously relevant support/resistance zone will hold and act the same as it did in the past. The price drivers (fundamental flavouring) at one point in time are never the same as they are in other points of time, so what was once an important level may now be completely ignored. Or it will be equally important. The fact is that on a price chart we, as chartist, can observe these important zones where buyers and sellers fought it out once before, and may very well fight it out again. 

Instead of trying to trade in the middle of nowhere, why not try to plan your trades around  something so evident and so simple to use, like a support or resistance area?

From Support and Resistance to Stop Clusters

Where's the link between support/resistance and stop orders? Take a look at the chart below.

Evident price zones harbour “2-way traffic”: buy orders and sell orders. 

Very useful to have on your chart.

Source: FXCM Marketscope

These kinds of price levels or zones are usually associated with a relatively large number of transactions (from both buyers and sellers) and that makes them consistent focal points. Because these areas tend to promote more trading, these areas see even more trading volume and have a tendency to reinforce themselves.  This is why areas of support and resistance usually repeat or stay in force.

There comes the time when the agents of support or resistance simply exhaust themselves and the price pattern breaks through the zone. This brings us to an important twist. These focal points harbour buyers and sellers. Often, once the buyers are exhausted, the zone becomes a good selling point (and vice versa). This might not seem very logical at first, but when we take into consideration the market's psychology, it can make more sense.

Source: proprietary illustration

In the chart above, let's assume traders buy at point 1. The market has a good advance, going to point 2 and the traders are feeling good. Then the market takes a bad turn and drops below their entry point, going towards point 3. Now the traders are concerned about holding onto a loosing position but still don't want to book a loss. They hold, hoping that the market will turn around and reach their entry point, so they can reverse their positions at point 4. So at point 4, the marketplace is flooded with sell orders. Re-cap: at point 1 we had support, at point 4 (same area) we have resistance. The opposite would be true for a resistance-becomes-support.