Markets gravitate to stop loss orders. In the old trading cliché, 'stops will be executed'.  But why should that be true?  To a retail trader it can seem a bit mysterious.  A currency can linger at a level for hours then all of a sudden it is gone, rocketing through levels and executing orders seemingly without reason or instigation.  This narration of a stop run a few years ago may provide an explanation.

In the end all that was necessary to end six months of currency market stagnation were two holidays and an old fashioned stop run.  Last Thursday was a holiday in United States and Japan (respect for Labor Day), markets in both countries were closed.    It must have been an uneasy two sessions for the few dealers in New York, Toronto, Sydney, Auckland and Tokyo who were watching their bank's order books. With the main centers, New York and Tokyo off line, very limited liquidity was available. The dealers' order books laid out the future. When Euro crossed 1.3000, they would have to buy large amounts of Euro.  For the dealers the prognosis was simple, when the Euro moved within striking distance of the stops above 1.3000 they would execute their orders; whoever bought Euro first had the best chance of survival.  And so it played.  In three minutes at the London open the Euro rose from 1.2995 to 1.3072.  A classic currency market stop run.  Six months of range trading erased in less than five minutes.

 There was no statistical trigger for this sudden change in market sentiment.  The economic picture in the United States and Europe is not appreciably different now than it was three months or even three weeks ago.  Why then are we trading two figures above the top of the old range? 

 When currency markets range trade for an extended period large numbers of stop loss orders accumulate on either side of the market. As the range since early summer had been 1.2450-1.2950 many stops were, by this time, arrayed above and below the limits of the range: sell stops below 1.2400 and buy stops above 1.3000. Once these stops are actuated, as they were by Friday's vault above 1.3000, the market will move violently in that direction as dealers buy Euro in the market to fulfill their order obligations. This concentrated buying drives the trading level higher, in turn activating more stops until all stops within reach are executed.  This is a classic currency market stop run and it is the immediate explanation for the move through 1.3000 on Friday and again through 1.3100 on Monday. 

Markets tend to gravitate to stops orders because dealers know that must execute quickly.  Stop loss markets move at speed. Each second can be worth 10, 20, 30 or more points.  Each point is loss.  As the market approached the 1.3000 level on Friday the pressure to execute became irresistible.   

The run was enabled by the returning liquidity of the London market. External news or events could have pushed the Euro higher at any time in the previous two sessions, prompting the stop executions.  But Sydney and Auckland dealers would have been reluctant to force the Euro into the stop territory themselves, as they could have, in the extremely limited liquidity of the two holiday markets.  If the stops were executed in the illiquid holiday markets, the upward price surge would have been far more violent and prolonged.  With few banks participating in the market the demand for Euro would have far outstripped the supply.   So the Asian dealers waited, nervously eyeing the market and their own order books, hoping that they would not be forced to execute their orders until the London market.

At 3:29 am the Euro was at 1.2990; the dealers began buying to cover their orders. At 3:33 am the Euro was at 1.3075. It happened like clockwork.