Stop Loss
Quick Answer
An order to sell a security when it reaches a certain price, designed to limit potential losses.
Why Use Stop Losses?
Stop losses are fundamental to risk management. They serve several purposes:
- Limit losses - Define your maximum acceptable loss before entering a trade
- Remove emotion - The decision to exit is made in advance, eliminating panic selling or hope-based holding
- Protect profits - Trailing stops can lock in gains as price moves in your favor
- Enable position sizing - Knowing your stop allows you to calculate proper position size
Types of Stop Losses
Fixed Stop Set at a specific price or percentage below entry. Simple but doesn't adapt to market conditions.
Trailing Stop Moves with price in your favor but stays fixed when price moves against you. Great for riding trends.
Volatility Stop Based on ATR or other volatility measures. Adapts to market conditions.
Time Stop Exit if the trade doesn't perform within a certain timeframe.
Where to Place Stops
Below Support (for longs) Place stops below key support levels where the trade thesis is invalidated.
Above Resistance (for shorts) Place stops above resistance levels for short positions.
Using ATR Multiple of Average True Range (e.g., 2× ATR) accounts for normal market volatility.
Avoid Round Numbers Stop hunting often occurs at obvious levels. Consider placing stops slightly beyond them.