How do you set up a stop

No one wants to lose money when they're playing the market. That's why it's important to set a floor for your position in a security. That's where stop-loss orders come in. But many investors have a tough time determining where to set their levels. Setting them up too far away may result in big losses if the market makes a move in the opposite direction. Set your stop-losses too close, and you can get out of a position too quickly.

So how can you tell where to set your stop-loss order? Read on to find out more.

Key Takeaways

• Stop-loss orders are placed with brokers to sell securities when they reach a specific price.
• Figuring out where to place your stop-loss depends on your risk threshold—the price should minimize and limit your loss.
• The percentage method limits the stop-loss at a specific percentage.
• In the support method, an investor determines the most recent support level of the stock and places the stop-loss just below that level.
• The moving average method sees the stop-loss placed just below a longer-term moving average price.

What Is a Stop-Loss Order?

A stop-loss order is placed with a broker to sell securities when they reach a specific price. These orders help minimize the loss an investor may incur in a security position. So if you set the stop-loss order at 10% below the price at which you purchased the security, your loss will be limited to 10%.

For example, if you buy Company X's stock for $25 per share, you can enter a stop-loss order for $22.50. This will keep your loss to 10%. But if Company X's stock drops below $22.50, your shares will be sold at the current price.

Slippage refers to the point when you can't find a buyer at your limit and you end up with a lower price than expected.

Determining Stop-Loss Order

Determining stop-loss order placement is all about targeting an allowable risk threshold. This price should be strategically derived with the intention of limiting loss. For example, if a stock is purchased at $30 and the stop-loss is placed at $24, the stop-loss is limiting downside capture to 20% of the original position. If the 20% threshold is where you are comfortable, place a trailing stop-loss.

Know where you are going to place your stop before you start trading a specific security.

There are plenty of theories on stop-loss placement. Technical traders are always looking for ways to time the market, and different stop or limit orders have different uses depending on the type of timing techniques being implemented. Some theories use universal placements such as 6% trailing stops on all securities, and some theories use security- or pattern-specific placements including average true range percentage stops.

Stop-Loss Placement Methods

Common methods include the percentage method described above. There's also the support method which involves hard stops at a set price. This method may be a little harder to practice. You'll need to figure out the most recent support level of the stock. As soon as you've figured that out, you can place your stop-loss order just below that level.

The other method is the moving average method. By using this way, stop-losses are placed just below a longer-term moving average price rather than shorter-term prices.

Swing traders often employ a multiple-day high/low method, in which stops are placed at the low price of a predetermined day's trading. For example, lows may consistently be replaced at the two-day low. More patient traders may use indicator stops based on larger trend analysis. Indicator stops are often coupled with other technical indicators such as the relative strength index (RSI).

What to Consider With Stop-Loss Orders

As an investor there are a few things you'll want to keep in mind when it comes to stop-loss orders:

• Stop-loss orders are not for active traders.
• Stop-loss orders don't work well for large blocks of stock as you may lose more in the long run.
• Brokers charge different fees for different orders, so keep an eye out for how much you're paying.
• And never assume your stop-loss order has gone through. Always wait for the order confirmation.

The Bottom Line

Traders should evaluate their own risk tolerances to determine stop-loss placements. Specific markets or securities should be studied to understand whether retracements are common. Securities that show retracements require a more active stop-loss and re-entry strategy. Stop-losses are a form of profit capturing and risk management, but they do not guarantee profitability.

What is a Stop-Loss Order?

Stop-loss orders are placed by traders either to limit risk or to protect a portion of existing profits in a trading position. Placing a stop-loss order is ordinarily offered as an option through a trading platform whenever a trade is placed, and it can be modified at any time. A stop-loss order effectively activates a market order once a price threshold is triggered.

Traders customarily place stop-loss orders when they initiate trades. Initially, stop-loss orders are used to put a limit on potential losses from the trade. For example, a forex trader might enter an order to buy EUR/USD at 1.1500, along with a stop-loss order placed at 1.1485. This limits the trader's risk of loss on the trade to 15 pips.

Key Takeaways

• A stop-loss order is designed to limit an investor's potential loss on a trade.
• The stop-loss effectively triggers a market order to buy or sell once a pre-set price threshold is reached.
• The advantage of a stop-loss order is you don't have to monitor how a stock is performing daily.
• The disadvantage is that a short-term fluctuation in a stock's price could activate the stop price.

How to Use a Stop-Loss Order

Once a trade is showing a moderate profit, a trader commonly adjusts the stop-loss order, moving it to a position where it protects part of the trader's profits in the trade. Continuing with the previous example, assume that after the trader buys EUR/USD at 1.1500, the price subsequently goes up to 1.1600. At that point, the trader may move their stop-loss order up to 1.1540, thus protecting almost half of their existing profit in the event the market turns down.

Traders sometimes use trailing stops to automatically advance their stop-loss order to a higher level as the market price rises. Trailing stops are easily set up on most trading platforms. The trader simply specifies the number of pips, or dollars, that they wish the stop order to trail behind the market high. Still using the EUR/USD example, if the trader specifies a 50-pip trailing stop when the market reaches 1.1600, the stop will automatically shift to 1.1550. If the market then rises to 1.1620, the stop will be advanced higher to 1.1570.

Stop-loss orders are a critical money management tool for traders, but they do not provide an absolute guarantee against loss. If a market gaps below a trader's stop-loss order at the market open, the order will be filled near the opening price, even if that price is far below the specified stop-loss level.

Stop-limit orders are similar to stop-loss orders, but as their name states, there is a limit on the price at which they will execute. There are two prices specified in a stop-limit order: the stop price, which will convert the order to a sell order, and the limit price. Instead of the order becoming a market order to sell, the sell order becomes a limit order that will only execute at the limit price or better.

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