How to Determine Where to Set a Stop Loss

Many investors struggle with the task of determining where to set their stop loss levels. Investors don’t want to set their stop loss levels too far away and lose too much money if the stock moves in the wrong direction. On the other hand, investors don’t want to set their stop loss levels too close and lose money by being taken out of their trades too early.

So where should you set your stop losses?

Let’s take a look at the following three methods you can use to determine where to set your stop losses:

  • The percentage method
  • The support method
  • The moving average method

The Percentage Method for Setting Stop Losses

The percentage method for setting stop losses is one of the most popular methods investors use in their portfolios.

[VIDEO] The Percentage Method Stop Loss

One reason for this method’s popularity is its simplicity. All you have to do when using this method is determine the percentage of the stock price you are willing to give up before you exit your trade.

For instance, if you decide you are comfortable with a stock losing 10 percent of its value before you get out, and you own a stock that is trading at $50 per share, you would set your stop loss at $45—$5 below the current market price of the stock ($50 x 10% = $5).

The Support Method for Setting Stop Losses

The support method for setting stop losses is slightly more difficult to implement than the percentage method, but it also allows you to tailor your stop loss level to the stock you are trading.

[VIDEO] The Support Method Stop Loss

To use this method, you need to be able to identify the stock’s most recent level of support. [Learn more about Support and Resistance.] Once you have done that, all you have to do is place your stop loss just below that level.

For instance, if you own a stock that is currently trading at $50 per share and you identify $44 as the most recent support level, you should set your stop loss just below $44.

You may be wondering why you wouldn’t just set your stop loss level at $44. The reason is you want to give the stock a little bit of wiggle room before deciding to exit your trade. Support and resistance levels are rarely accurate to the penny so it is important to give the stock some space to come down and bounce back up off of its support level before pulling the trigger.

The Moving Average Method for Setting Stop Losses

The moving average method for setting stop losses is more simple than the support method, but it also allows you to tailor your stop loss to each stock.

[VIDEO] The Moving Average Method Stop Loss

To use this method, you need to apply a moving average to your stock chart. Typically, you will want to use a longer-term moving average as opposed to a shorter-term moving average to avoid setting your stop loss too close to the price of the stock and getting whipped out of your trade too early.

Once you have inserted the moving average, all you have to do is set your stop loss just below the level of the moving average.

For instance, if you own a stock that is currently trading at $50 and the moving average is at $46, you should set your stop loss just below $46.

Just as in the example above using the support method, you should set your stop loss just below the moving average to give the stock a little room to breathe.

 

Image Courtesy of Randy Son of Robert.

  • Anussh Mokashi

    Calculating stop loss using beta factor would be a too hectic task…

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  • ford

    the best place to kep a stoploss is as p[er jimberg. 2 times atr below entry.

  • Chivenyc

    Question about setting up a stop loss using a support level.  I have read and/or heard that some set a stop loss 1 cent below support, some 5 cents, some use a small fixed %.  I would like to use a stock’s beta to address its volatility.  How would you recommend setting up a support level stop loss with a particular stock’s beta?

    • Chivenyc, could you give us some more detail on how you plan on using beta to determine a stop loss or how you have used it in the past?

      • Bill

        Hmm… I had the same Question as Chivenyc, but
        see no answer here. What is the answer?

  • A. Jones

    I enjoyed the article on stop loss implementation and have a question on the MA method. Using the 200 day MA how difficult is it to calculate the 200 day MA and then how long will it take to implement your stop loss order? If this is a lengthy process are you not better served by using a simple % method? Thx.

    • A,

      You can display a 200 period moving average on your charts automatically. The level should not change too much on a day to day basis but you could revise your stop loss on a daily basis to match where the moving average is at that time. It shouldn’t take longer than a minute or two. However, I think your suggestion of a fixed % seems fine. In my opinion the key to successfully using stops it to keep them wide (avoiding whipsaws) and stay consistent.

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