A stop loss is an order that sells your position automatically if the price falls to a level you pick in advance. You buy a stock at $50, you decide you're wrong if it drops to $47, so you place a stop at $47. If the price hits $47, your broker sells. You lose about $3 a share, and nothing more.
That's the whole idea: you decide how much a trade is allowed to cost before you're in it, while you're still calm.
Why every trade needs one
Most big trading losses don't come from one bad idea. They come from a small loss that the trader refused to take. The stock drops 5%, then 10%, then 25%, and the trader keeps "waiting for it to come back". A stop loss makes that decision for you.
It also makes the rest of trading possible. Once you know where you'll get out, you know your risk per share, and from that you can work out how many shares to buy (see the position size calculator).
The main types of stop orders
- Stop (stop-market) order: when the price touches your stop, it becomes a market order and sells at the next available price. It almost always fills, but not always at your exact price.
- Stop-limit order: when the stop is touched, it becomes a limit order at a price you set. You won't sell below your limit, but if the price drops straight through it you may not sell at all, which defeats the purpose for most beginners.
- Trailing stop: the stop follows the price up by a fixed amount or percent, and never moves down. Useful for letting a winner run while protecting profit.
Where to put your stop loss
A good stop sits where your reason for the trade stops being true, not at a round number of dollars you're comfortable losing. Three common ways:
- Below structure. Just under the most recent swing low or a clear support level. If price breaks that level, the setup has failed.
- ATR-based. ATR (average true range) measures how much a stock normally moves in a day. A stop 1.5 to 2 ATR below entry sits outside the normal daily noise, so you're not shaken out by an ordinary wiggle.
- Percent-based. A fixed 5-8% below entry. Simple, but it ignores how volatile the stock is: 5% is a lot for a utility stock and nothing for a small-cap tech stock.
Try all three with the stop loss calculator.
Example
You have a $10,000 account and you're willing to risk 1% ($100) on one trade. A stock trades at $50 and its recent swing low is $47.60, so you set the stop at $47.50.
- Risk per share: $50 − $47.50 = $2.50
- Shares to buy: $100 ÷ $2.50 = 40 shares ($2,000 position)
If you're wrong, you lose $100, which is 1% of the account. You could be wrong ten times in a row and still have 90% of your money.
Mistakes beginners make
- Stops that are too tight. A stop 1% below entry on a stock that moves 3% a day will get hit by normal noise. Use the ATR to check.
- No stop "just this once". The one trade without a stop is the one that gaps down 30%.
- Moving the stop down. Moving a stop further away to avoid being stopped out turns a planned loss into an unplanned one.
- Forgetting gaps. A stop doesn't protect you overnight. If bad news hits after the close, the stock can open far below your stop, and you're filled at the open price.
Key takeaway
Decide where you're wrong before you buy, put a stop there, and size the trade so that being wrong costs a small, known amount.
