No one wants to lose money when they're playing the market. That's why it's important to set a floor for your position in a security. That's where stop-loss orders come in. But many investors have a tough time determining where to set their levels. Setting them up too far away may result in big losses if the market makes a move in the opposite direction. Set your stop-losses too close, and you can get out of a position too quickly.
So how can you tell where to set your stop-loss order? Read on to find out more.
Key Takeaways
- Stop-loss orders are placed with brokers to sell securities when they reach a specific price.
- Figuring out where to place your stop-loss depends on your risk threshold—the price should minimize and limit your loss.
- The percentage method limits the stop-loss at a specific percentage.
- In the support method, an investor determines the most recent support level of the stock and places the stop-loss just below that level.
- The moving average method sees the stop-loss placed just below a longer-term moving average price.
What Is a Stop-Loss Order?
A stop-loss order is placed with a broker to sell securities when they reach a specific price. These orders help minimize the loss an investor may incur in a security position. So if you set the stop-loss order at 10% below the price at which you purchased the security, your loss will be limited to 10%.
For example, if you buy Company X's stock for $25 per share, you can enter a stop-loss order for $22.50. This will keep your loss to 10%. But if Company X's stock drops below $22.50, your shares will be sold at the current price.
Slippage refers to the point when you can't find a buyer at your limit and you end up with a lower price than expected.
Determining Stop-Loss Order
Determining stop-loss order placement is all about targeting an allowable risk threshold. This price should be strategically derived with the intention of limiting loss. For example, if a stock is purchased at $30 and the stop-loss is placed at $24, the stop-loss is limiting downside capture to 20% of the original position. If the 20% threshold is where you are comfortable, place a trailing stop-loss.
Know where you are going to place your stop before you start trading a specific security.
There are plenty of theories on stop-loss placement. Technical traders are always looking for ways to time the market, and different stop or limit orders have different uses depending on the type of timing techniques being implemented. Some theories use universal placements such as 6% trailing stops on all securities, and some theories use security- or pattern-specific placements including average true range percentage stops.
Stop-Loss Placement Methods
Common methods include the percentage method described above. There's also the support method which involves hard stops at a set price. This method may be a little harder to practice. You'll need to figure out the most recent support level of the stock. As soon as you've figured that out, you can place your stop-loss order just below that level.
The other method is the moving average method. By using this way, stop-losses are placed just below a longer-term moving average price rather than shorter-term prices.
Swing tradersoften employ a multiple-day high/low method, in which stops are placed at the low price of a predetermined day's trading. For example, lows may consistently be replaced at the two-day low. More patient traders may use indicator stops based on larger trend analysis. Indicator stops are often coupled with other technical indicators such as the relative strength index (RSI).
What to Consider With Stop-Loss Orders
As an investor there are a few things you'll want to keep in mind when it comes to stop-loss orders:
- Stop-loss orders are not for active traders.
- Stop-loss orders don't work well for large blocks of stock as you may lose more in the long run.
- Brokers charge different fees for different orders, so keep an eye out for how much you're paying.
- And never assume your stop-loss order has gone through. Always wait for the order confirmation.
The Bottom Line
Traders should evaluate their own risk tolerances to determine stop-loss placements. Specific markets or securities should be studied to understand whether retracementsare common. Securities that show retracements require a more active stop-loss and re-entry strategy. Stop-losses are a form of profit capturing and risk management, but they do not guarantee profitability.
FAQs
Stop-loss orders are placed with brokers to sell securities when they reach a specific price. Figuring out where to place your stop-loss depends on your risk threshold—the price should minimize and limit your loss. The percentage method limits the stop-loss at a specific percentage.
How to determine where to put stop loss? ›
A common practice is to set the stop-loss level between 1% to 3% below the purchase price. For example, if you buy a stock at Rs. 300 per share, a 2% stop loss would be triggered at Rs. 294, helping you limit potential losses while accommodating normal market fluctuations.
How do you calculate what your stop loss should be? ›
The stop loss price = the entry price – the stop loss size. Suppose you buy a financial instrument at 1.32000, and the stop loss is 50 price points (pips). How to calculate the stop loss if you open a short position (sale): The stop loss price = the entry price + the stop loss size.
What is the 7% stop loss rule? ›
Always sell a stock it if falls 7%-8% below what you paid for it. This basic principle helps you always cap your potential downside. If you're following rules for how to buy stocks and a stock you own drops 7% to 8% from what you paid for it, something is wrong.
What should I set my stop losses at? ›
An active trader might use a 5% level, while a long-term investor might choose 15% or more. Another thing to keep in mind is that, once you reach your stop price, your stop order becomes a market order. So, the price at which you sell may be much different from the stop price.
What is the 2 stop-loss rule? ›
The 2% rule in investing suggests that you should never risk more than 2% of your capital on any single trade or investment. This approach helps manage risk by limiting potential losses and preserving capital for future opportunities.
What is the 6% stop-loss rule? ›
The 6% stop-loss rule is another risk management strategy used in trading. It involves setting your stop-loss order at a level where, if the trade moves against you, you would only lose a maximum of 6% of your total trading capital on that particular trade.
What is the golden rule for stop loss? ›
The golden rule of Stop Losses is that they should never be moved away from the market once the trade is opened. If a trader feels that their stop loss is incorrectly placed, they are recognising that the foundations of their trade are incorrect and therefore they should close out.
What is the rule of thumb for stop loss? ›
One popular method is the 2% Rule, which means you never put more than 2% of your account equity at risk (Table 1). For example, if you are trading a $50,000 account, and you choose a risk management stop loss of 2%, you could risk up to $1,000 on any given trade.
What is the 1 stop loss rule? ›
What is 1 % stop loss rule? - Quora. Your Stop Loss should not exceed 1% of your total capital. It helps you building discipline and also ensures protection to your capital. Say suppose, your capital is 10k, by rule, your SL should not exceed 1% of 10k = Rs100.
When you use a stop loss order properly you can minimize your risk and stay in the industry for the long haul. If you are using a stop loss order incorrectly you will find that it is always getting hit, then the trade reverses and moves immediately back in your direction.
What is the trigger price for stop-loss? ›
In case of a Sell order, the stop-loss trigger price is higher than the Sell price. Trigger price is the price at which your buy or sell order becomes active for execution at the exchange servers. In other words, once the price of the stock hits the trigger price set by you, the order is sent to the exchange servers.
What is the 3000 loss rule? ›
Capital losses that exceed capital gains in a year may be used to offset capital gains or as a deduction against ordinary income up to $3,000 in any one tax year. Net capital losses in excess of $3,000 can be carried forward indefinitely until the amount is exhausted.
How do I know where to set stop loss? ›
When deciding where to set a stop-loss, traders might account for fluctuation or volatility in the market. The historical movement of the asset and its financial market is also a good indication of where to set your stop-loss.
How to calculate your stop loss? ›
For example, your stop is at X, and long entry is Y, so you would calculate the difference as follows:
- Y - X = cents/ticks/pips at risk.
- Pips at risk X Pip value X position size.
- OR.
- 6 pips at risk X $1 per pip X 5 mini lots = $30 risk (plus commission)
- 5 ticks X $12.50 per tick X 3 contracts = $187.50 (plus commissions)
What stop-loss percentage should I use? According to research, the most effective stop-loss levels for maximizing returns while limiting losses are between 15% and 20%.
Where to place a stop order? ›
When a stop order is submitted, it is sent to the execution venue and placed on the order book, where it remains until the stop triggers, expires, or is canceled by the trader. Once triggered, a stop order becomes a market order, which will generally result in an execution.
Where do you put stop-loss in day trading? ›
Day Trade Stop Loss Order
Most of the day, traders set the stop-loss value above the price they have bought the stock when the trend is booming upwards. In such a case, if the trend falls or there is a downtrend, the trader at least has some profit in the pocket.
How do you calculate position size based on stop-loss? ›
Subtract the stop-loss from the entry price for a long position, or subtract the entry price from the stop-loss for a short position. This figure represents your risk per share (or per unit, such as the contract size if you're trading stock indexes or commodities in the futures market, for example).
