Trader Tips
Jun. 14, 202113 min read

Stop-Loss: What It Is, Examples, & Top Strategies to Use

Tim BohenAvatar
Written by Tim Bohen

What’s a stop-loss … and how the heck do you use it?

You know it’s important to cut losses quickly. We say it all the time at StocksToTrade. If you wanna stay in the trading game, you have to learn to do this.

But how does it really work? How do you stick to the stop-loss you set in your trading plan?

A stop-loss order can be an effective way to automate this process. Today we’ll dive deep and review this common trade order…

  • What are the different kinds of stops losses?
  • How do you use them?
  • And how can they reduce your risk?

Read on to find out more about how stop-losses can help you trade smarter every day.

What Is a Stop-Loss Order?

A major key to limiting your trading losses is planning your trades. That includes your entries and exits. You have to set how much you’ll lose if the trade doesn’t go your way — ahead of time

Newer traders often like to do this automatically using stop-loss orders, also known as stop orders.

A stop-loss order exits you out of your position if your stock hits your set stop price. The stop is the price where you want to cut your losses.

If the stock hits that stop, your market order is automatically filled. Stop-loss orders can be useful … They can prevent emotions from interfering with cutting losses. It’s too easy to think the trade will turn around. And when it doesn’t, you end up with a big loss.

Importance of a Stop Loss

When you’re trading, it’s important to safeguard yourself from losses. Losses aren’t fun, right? But unfortunately, they happen. It’s just not possible to have every trade work. It even happens to big hedge funds.

So don’t beat yourself up, it’s part of the trading process. You might think this is negative thinking…

But realistically, any trade has a solid chance of not going your way. It’s important that you mentally prepare to lose. It will happen over and over again.

Newer traders sometimes forget how crucial it is to protect their capital. But if you don’t think about it — and especially if you trade with a small account — you can blow up your account fast.

So every time you enter a trade, you have to consider where to set your stop loss.

It’s super critical if you’re aren’t good at cutting losses yet. Your ultimate goal is to preserve capital and to avoid blowing up your account. Once you do that, you’re out of the game. And it’s not always easy to start over.

Stop Loss vs Stop Limit Order

A ton of new traders aren’t sure what a stop-limit order is. Luckily, it’s fairly straightforward.

The stop is your trigger price. The stop is below your buy price on a long stock and above your sell price on a short stock. 

The stop-loss order then turns into a limit order when the stock hits your stop.

For the rest of the article, we’ll focus on the long side. For the short side, the price would be on the opposite side of the stated direction. (Top becomes bottom, the high becomes the low, the uptrend becomes the downtrend, and so on…)

But if you’re a newbie, tread carefully with short strategies. This is a tricky way to trade.

Trailing Stop Loss Order

A trailing stop loss is similar to a regular stop loss. It tracks the highest price of an uptrending stock. When the stock makes a new high, this price becomes the top price.

Its stop limit moves up with the top price. That’s because you determine how much below the top price you’ll allow it to drop. This is either a set percentage or amount below the top price.

When it hits the stop, it uses a market order to exit your position. 

This is great for both swing traders and part-time traders. It allows you to ride a stock as it uptrends and exit when the uptrend reverses a certain percentage. This would indicate the potential end of the trend.

The downside of this order is that you can’t place it at the key level you want. It doesn’t account for support and resistance or half-dollar and whole-dollar levels.

Trailing Stop Limit Order

The trailing stop limit order is a trailing stop-loss order with a limit order attached to it. I suggest using this order when you need a trailing stop-loss order. It prevents you from exiting at a poor price, and the limit is set as a percentage of the stop order.

Playing trades over a multi-day time frame can work for a lot of different traders. So, this order can be useful when you’re following a trade that’s grinding higher … We look for trade like this all the time at StocksToTrade Pro. 

Up your trading game with chat rooms, live webinars, and more. Come join our StocksToTrade Pro trading community. 

How to Set a Stop Loss

It’s fairly easy to set up a stop-loss. You just need to choose it in the trade order type. I recommend choosing the stop limit or trailing stop-limit orders. The others execute at market price — which is risky.

Once you select your order type, enter your stop price. We’ll get into how to choose a stop price in a bit.

The stop price is a set price in a stop-limit order. But in a trailing stop-limit order, this is the dollar amount you’ll allow the stock to go below the top price or delta. You can also enter a percentage amount for the delta if you prefer.

You then enter your limit order. This is to make sure you get executed at a reasonable price.

With blue-chips and other larger stocks, it’s usually not an issue. 

But on the fast-moving low-priced stocks we love to trade at StocksToTrade Pro, there needs to be at least 1% cushion depending on the liquidity. Less liquid stocks need a bit more room … and we don’t trade the illiquid stocks.

Risk vs. Reward

If you set your stop too close to your entry price, volatility can shake you out. But if you set it too far, you’ll lose more capital than necessary. So where should you place your stops? Or more importantly…

What should you risk?

It’s impossible to talk about stop losses without discussing risk. This is the amount of money you’ll lose if the trade doesn’t go your way. 

Always place your stop where there’s a decent risk/reward ratio. Your reward is ideally twice or greater than your risk. If you risk $10 to make $50, you have a risk-reward ratio of 5:1. It’s a simple calculation…

Reward Amount / Risk Amount = Risk-Reward Ratio

Illiquid Stocks

Stay away from illiquid stocks. Take it from traders who’ve been there. Yep, even me. I learned this the hard way too many times.

Only trade liquid stocks. Illiquid stocks can blow through your stop fast. That means you’re stuck in the trade. Your order might not get executed at all. Or your order might get filled far below your planned exit price. 

An illiquid stock multiplies your risk level substantially. It sucks getting trapped in stock watching your losses stack up. My tip: avoid illiquid stocks altogether.

So what’s a liquid stock? Stocks that are traded a lot are liquid. My general guideline is to avoid stocks that trade under one million shares per day. That’s the low end of the spectrum. Higher is better. 

But any less than one million and there might not be enough volume for you to exit if the trade goes south.

Stop Loss Order Calculator

Let’s say you’re buying stock XYZ at $100. You believe the stock can go up to $130. You calculate your risk management to find the amount you’re willing to risk before the trade. In this case, the reward is $30… 

Target Price – Buy Price = Reward Amount

You decide to use a 3:1 risk-reward, and you believe the stock can gain $30. This gives you a risk amount of $10.

Reward Amount / Risk-Reward Ratio = Risk Amount

This means you’d place your stop-loss price at $90.

Buy Price – Risk Amount = Stop-Loss Price

On the other hand, you could decide to risk $30. You believe the stock has an almost guaranteed chance of going up $30, right? 

But hold up…

This is a classic mistake for new traders. In this case, it’s a 1:1 risk-reward. It’s not a great choice. Most traders lose over a third of the time. Plus, you gotta remember all your overhead expenses as well. Over time, you’ll only lose money.

Stop Loss Strategies 

Use Stop Loss to Calculate Position Size 

Many traders calculate their initial position size based on their risk. 

Let’s say you wanna know how many shares of XYZ stock to buy. You decide that $100 of your portfolio is the most you want to risk on a trade. Using the above example, the risk amount is $10. So the number of shares you’d buy is 10 shares at $100.

Share Amount = Portfolio Risk / Risk Amount

You have a 3:1 risk-reward, so…

  • Your potential loss here is $100.
  • And your potential gain is $300.

Use Stop Limit Orders to Buy on Breakouts

A strategy for more advanced traders is to buy breakouts immediately as they happen.

Let’s say there’s an OTC stock that’s uptrending toward the $1 resistance level. You think it has both the volume and catalyst it needs to break out. But you aren’t sure it can run before it breaks out through the resistance level. 

You want to buy it immediately as it breaks out as it might continue to run on momentum.

Remember, first you gotta be sure the stock is liquid enough for you. So make sure to avoid thinly traded OTCs. High volume is key.

Here you can place a buy stop-limit order. You’d place it just above the breakout price — $1.01 in this case.

Sometimes a fast-moving stock can break out so fast your order isn’t executed. So, you need an adequate cushion to account for a rapid rally. Usually, a 2% cushion can work well to catch most breakouts. So you place your limit order at $1.03.

That way, you can catch a quick breakout as it occurs.

Remember to account for risk! A breakout might dip back under resistance before continuing or fail altogether.

Use Trailing Stop Orders to Trend-Follow Runners

This strategy can work for trend-following multi-day runners or initial public offerings (IPOs). You’re trying to capture the majority of the stock’s uptrend, then exiting once it starts reversing.

Set a stop percentage below the top price that indicates to you the run is over. Give yourself an appropriate limit — a 2% cushion can work well. Once the run is over, if all goes well, you can cash out.

Keep in mind that multi-day runners can have panics … but then continue higher. Take this into account when setting your stop percentage.

Multi-day runners are my favorite step to trade. I love uptrending stocks that keep making new highs. We discuss them a lot in StocksToTrade Pro

And you can track these multi-day runners with the StocksToTrade platform. This is a no-nonsense platform for dedicated traders. StocksToTrade was developed by traders who take trading as seriously as you do.

With StocksToTrade, you can quickly scan for the daily top percentage gainers. Then, make a watchlist of big movers so you can try to catch the next big trend.

StocksToTrade features top-of-the-line charting, thorough stock scanning, custom watchlists, news scanning, and more. It’s all in a clean interface that’s easy to use.

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While there are many strategies that use stop-loss orders … the most crucial thing you can learn when trading is to manage your risk. 

This is key to your trading foundation. It can take some getting used to, especially if you’re eager to jump right in. But your education is key. The market is a battlefield … and 90% of traders lose.

A lot of them lose because they don’t think they need an education. They don’t prepare. They jump in without a plan. That’s just gambling.

If you want to have a long trading career, you need to outsmart the competition. 

That’s why at StocksToTrade Pro, we focus on how we can be better traders every single day. We want you to become a knowledgeable and informed trader too… 

Wanna see how I trade every day? Join me and an amazing group of traders at StocksToTrade Pro now! And keep tabs on the StocksToTrade blog and SteadyTrade podcast. These are totally free resources.

Stop-loss orders can be an important tool for traders and investors. They can help automate a good trading plan and reduce your risk. It’s one way to get into the habit of cutting your losses. 

How do you cut losses? Do you use stop losses? Leave a comment below!