What Percentage Should I Set for a Stop Loss When Investing in the Stock Market?

Stop-loss orders help traders conserve capital.

Stop-loss orders help traders conserve capital.

Stop-loss orders allow traders to limit their losses in the stock market. Selecting the best price level for a stop-loss can be one of the most important trading decisions a stock investor makes. Some traders use a percentage of their profit target to set order levels, but different strategies can be better suited to different scenarios. Understanding common strategies for placing stop-loss orders can help you to increase your consistency as a trader.

Prevention Technique

As the name implies, a stop-loss order prevents a loss on a trade past a designated point. They are placed within a software trading platform and attached to an existing trade. When that trade is live in the market a stop-loss immediately closes a position when the price of a given asset hits a certain level. Stop-losses are placed below the market price for buy orders and above it for sell orders or short sales.

Profit Target

Setting your stop-loss as a percentage of your profit target can keep your risk-to-reward ratio in favorable territory. Having your stop-loss at 50 percent of your profit target or less can increase your chances of earning a net gain over the long term. For instance, buying a stock at $25 and intending to sell when it reaches $27 means your profit target is $2. If you set your stop-loss at $24 it will be $1 away from the purchase price, or 50 percent of the profit target.

Max Loss

Using the maximum loss per trade from your risk-management plan can inform your stop-loss levels. Setting a maximum loss per trade can ensure that your trading account does not lose too much of its value in a single losing day, especially when used alongside a target for the maximum loss per day. With this method, investors calculate how much a current trade can decline, given the current price and the number of shares in the trade until it reaches the maximum loss for the trade. Consider an investor with a $100 maximum loss per trade. If the investor buys 50 shares of a $10 stock, he will lose $50 on the trade for every dollar that the price declines. Thus, he could set a stop-loss at $8 -- the point at which he would have lost $100 on the trade.

Support and Resistance

When a stock's price rises above a resistance level or falls below a support level, it is often likely to continue in that direction. Thus, setting a stop-loss order at these points can get you out of a trade that is likely to lose more value than it already has. These stop-losses can be far enough away to avoid pulling you out of a losing trade that is about to turn back in your favor.


About the Author

David Ingram has written for multiple publications since 2009, including "The Houston Chronicle" and online at Business.com. As a small-business owner, Ingram regularly confronts modern issues in management, marketing, finance and business law. He has earned a Bachelor of Arts in management from Walsh University.

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