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Determining the Proper Stop Loss

Some traders trade without a stop loss, some investors invest without a stop loss. A stop loss offers extra protection against loss, but some people just like to live life on the edge. However, using a protective stop can help you safeguard your portfolio against unnecessary loss. Are you familiar with the use of protective order types?

What is a Stop Loss?

A stop loss is an order type. A buy or a sell are also order types. When you first place your stock order, you have a few options. You can choose to place a market order which is possible and will only execute when the market is open. That order will execute at the market price. You do not have control over the price at which your order gets filled. You can place a buy or sell order that can be executed even if the market is not open, limit orders are usually used for this. A stop order is an order that can be executed even if the market is closed. If you are long, or on the buy side of the trade, a stop would be placed under the current price at some point of loss in case the price drops down. If you are on the sell side of a trade, you would set the stop somewhere above the current trading price.

Why Do I Need a Stop Loss?

If you are actively managing your own portfolio you will need to be familiar with a stop loss. Even if you plan a buy and hold strategy, it is good to know how to use a stop loss in the event of unexpected market volatility. A stop order can protect your portfolio on the downside and prevent unnecessary losses.

Where Should I Set My Stop Loss?

This is the biggest question that is asked when stop losses are discussed. It really depends on what you are willing to lose and how you view the trade. Is this a buy and hold? You may be ok with setting the stop loss to a 50% loss or maybe 70%. Are you testing a strategy or making a short term trade? You may want to set your loss at only 10 to 15% of the trade value. Whatever you decide you should make sure to set the trade as ‘good til canceled’ and not just good for the day. That way your stop will only expire when it is canceled by the exchange, typically in 30 days or within a calendar month.

Advanced Method: Trailing Stop Techniques

There are other ways to set stop losses that can prevent a huge loss but also lock in current gains. A trailing stop is a stop that moves as your position gains in value. Think of it as a spy who follows you as you are walking in the park but each time you stop and look back, he hides behind a tree. If you walk backward, he’ll eventually catch you because he never walks back. A trailing stop is basically the same. As your trade wins, the stop will move up protecting you in case the price drops to the stop level; however, if the price keeps going up, the trailing stop keeps going up. If the price continues to rally, eventually the stop will cut you out of the position at a gain. These type of orders are really good to use if you are not planning on actively trading.

A stop loss can be beneficial to you if you are a buy and hold investor or a trader. Do you use a stop loss when you are planning to exit a trade?

Stop right there! LaTisha is a writer for Financial Success for Young Adults where she talks trading, investing and shares tip and techniques for beginners.

9 thoughts on “Determining the Proper Stop Loss

  1. One of the reasons that I got out of playing the market is that I couldn’t for the life of me get the stop losses right. I’d always set them too conservatively – and with the market volatility at the time, I’d end up taking a loss when the stocks themselves were just bouncing. Thank you for this post. :) You explain this a lot better than I do.

  2. I use the trailing stop method for mine, typically on a percentage. I got burned on Apple last year as I had set a 15% trailing loss. It hit my number and triggered a sale. It went down maybe a couple pennies lower and has been going up ever since. Kind of unlucky on that one. It’s all about finding the right percentage to protect yourself both ways.

  3. I think if you are investing for the long term and don’t plan on using the money right away from you investments than it makes more sense to hold and not sell. For us, we do a fair portion of index investing where this wouldn’t make much sense.

  4. It seems to me that the following:

    “that can be executed even if the market is closed”

    is in error. Stop orders convert to market orders when the trigger price is hit, and thus can only execute under the conditions a market order can. For stocks, that would generally imply “regular trading hours” – 9:30 to 4:00 EST in the US. You generally don’t WANT a stop to execute after hours even if your broker supports that behavior – the execution price can be a long ways worse than the trigger price because the market is so thin.

    That said, a conventional RTH stop is a good tool for most traders and investors if placed appropriately.

    This might also be interesting reading: http://www.offroadfinance.com/2011/10/26/more-about-stop-orders-and-false-breakouts/

  5. I don’t use stop losses ever since the flash crash and mini flash crash, it’s too easy to lose money and the position due to computer error, rumors, or speculation. If we’ve learned anything from the volatility this past year, stocks can drop fast and quickly turn around for big gains. There’s no need taking a chance triggering a stop loss only to see that stock end the day positive.

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