What Percentage Stop Loss Should You Use?

Before the market takes you to the cleaners, you use a stop loss order. As the term states, stop loss is the trading exit point used to limit the amount of loss. Say you want a stock price to move upwards. If the price drops too low, you will want to get out of there and stop trading.

Some traders do not use a stop loss, but it is highly recommended to avoid problems. There are two types of exits, called a regular exit and a backup exit. When regular exit is used as the sole stop loss, it is kept close to the current price. Backup exit, also called an emergency exit, is used as a last resort and is kept far away from the current price.

As to what percentage stop loss to use, you will get all sorts of numbers, as there is no only way or right way to exit a bad trade. Time frames, stock volatility, risk, reward and portfolio value all need to be taken into account. If anything, stops must be logical. For example, you don't want to hit the exit when the stock is on the upward trend.

Some people find placing a stop just below the support level useful with intraday timeframes. A common stop for longer trading is the Average True Range (ATR) system. Share trading range is also important; you will be stopped quickly if set your exit within the average day trading. Intraday timeframes should look into intraday support, for example.

Before setting a stop, be clear about your risk per trade (general recommendation is 1-3 percent) and how much money you are willing put into each share (money management). Let's take stock ABC. Say asking is 5c and chart support shows 5.4c. If your stop loss is set at 1 percent of $100,000 (or $1000), you can buy 250,000 shares at $12,500 (1,000/0.004 = 250,000).

Position size is also important when setting stop losses. For example, X is trading $100,000 and is willing to part with $1000 on any one trade. X loses his $1000 if the close is under the exit point. X gets out with a loss less than $1000 if the exit moves up. A larger position size is possible with a stock that has a lower entry stop percentage.