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Determining Where to Set Your Stop-Loss
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Determining Where to Set Your Stop-Loss
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Updated November 29, 2021
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Guide to Trade Order Types
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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
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 OrderDetermining 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 MethodsCommon 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 OrdersAs an investor there are a few things you'll want to keep in mind when it comes to stop-loss orders:
The Bottom LineTraders 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. Article Sources
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Related Terms
Protective Stop
A protective stop is a stop-loss order deployed to guard against losses, usually on profitable positions, beyond a specific price threshold.
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Trailing Stop Definition and Uses
A trailing stop is a stop order that tracks the price of an investment vehicle as it moves in one direction, but not in the opposite direction.
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Stop Hunting
Stop hunting is a strategy that drives the price of an asset to a level where many investors may have set stop-loss orders.
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What Is Gapping?
Gapping occurs when a stock, or another trading instrument, opens above or below the previous days close with no trading activity in between.
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Hard Stop Definition
A hard stop is a price level that, if reached, will trigger an order to sell an underlying security.
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Stop-Loss Order Definition
Stop-loss orders specify that a security is to be bought or sold when it reaches a predetermined price known as the spot price.
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