Intermediate4 min readRisk and Portfolio Management · 3/11
Stop Loss: How to Set It
A stop loss is the price at which, if the stock gets there, you exit and accept that you were wrong. The hard part is not executing it; it is choosing where it goes, before you enter.
What you will learn
Place the stop where your reason fails, not where the pain starts.
See why the stock's normal movement matters for where the stop goes.
Understand the ways to carry out a stop and the limits of each.
The lesson as a short video · 20 seconds · Watch on YouTubeIn this lesson
A common mistake is saying "I will exit if I lose 5%" without looking at the stock itself. That number is comfortable for you, but the market knows nothing about it. A clearer way is to ask: what would have to happen for my reason to buy to be gone? Then put the stop at that level.
If you bought because the price bounced off a support level, a clear break of that support is what says you were wrong. If you bought on a specific piece of news, the stop is tied to that news. If you use a price stop, try to tie it to a level consistent with your reason for entering.
Leave room for normal movement
Every stock has a normal daily range it moves within without anything changing. Put the stop inside that range and a perfectly ordinary move can knock you out before the price carries on the way you expected. So stops usually sit a little below the level, not exactly on it.
Entry price25.00
A clear support level23.50
Normal movement room below support0.30
Stop loss23.20
The stop sits below support by the normal movement room, not exactly on it.
A worked exampleYou bought an invented company, Delta Pharma, at EGP 25 because it bounced off support at 23.50. The stock typically moves about 0.30 either way in a day, so you set the stop at 23.20. The loss per share is 25 - 23.20 = 1.80. If the most you accept losing is EGP 900, that is 900 ÷ 1.80 = 500 shares.
Notice the order: the stock decided where the stop goes, and the stop decided the number of shares. If the sensible stop is far away, you buy fewer shares; you do not move the stop closer.
How will you carry it out?
A stop order with your brokerSome brokerage firms offer orders that trigger by themselves when the price reaches a level. What is available and how it works differs by firm, so ask yours.
A price alertIt tells you when the price reaches the level; the decision and the order are then up to you.
A stop in your headNo order, no alert. The easiest one to forget or postpone just when the price gets there.
Watch outA stop does not guarantee you exit at exactly that price. If the stock opens below it or falls fast, the fill can be worse. And if the order has a price limit, it may not fill at all while the price keeps falling.
Set an alert at your stop
Create a price alert on the stock at the level you chose, so you know as soon as it gets there.