A prudent risk management strategy in financial markets is using stop losses to protect your downside - even if you are short - but is this yet-to-be-fulfilled order able to be gamed by other market participants?

Short answer is YES but first lets define what we mean by stop orders, in the context of a short position.

A buy stop order is an order to buy a given security at a specified buy stop order price. This order is only activated once the security's market price rises above the specified buy stop price. The advantage of a stop order is you don't have to monitor how a stock is performing on a daily basis. However, the disadvantage is that the stop price could be activated by a short-term fluctuation in a stock's price and worst, once your stop price is reached, your stop order becomes a market order and the price you receive may be quite different to the stop price, especially in a fast-moving market where stock prices can change rapidly.To mitigate this risk investors can use buy stop-limit orders...

A buy stop-limit order is the same only the order is a limit order once the buy stop price has been reached. Thus a stop-limit buy order, if triggered and fulfilled (it's not guaranteed to be executed), buys the security at or below the specified limit price.

So why buy something in the future at a higher price than it is trading at now? There are several reasons:

  1. you have short-ed the security and want to limit the loss (you lose when the stock goes up);
  2. you are a momentum trader and want to buy only when you see a certain amount of momentum (momentum traders reason that the current trend in prices is more likely to continue in the same direction, rather than revert);
  3. in a declining market you expect a stock to "rebound" and want to buy just after the turn-around.

How can such stop orders be manipulated? Well, large market participants can look at price movements over time and perform similar analysis that "chartists" do and figure out where clusters of stop orders might be - in the near vicinity of trades by people with limited downside tolerance, or at so-called "levels of resistance". With deep enough pockets, large participants can buy the security to force the price up until it triggers the anticipated stop order prices. When that happens market forces drive the price even higher and the manipulator can sell out with a profit. Of course, the risk for the manipulator is that the stop orders do not exist, or the price doesn't reach them and they must close out their positions at a loss.

Apparently, this is called "gunning the stops".

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