How to Stop Loss
What are Stop Losses?
Stop Losses are preset triggers that will close out a position at a certain price point — usually to limit how much you might lose if the price action moves against you.
Etoro has stop losses that you can set at a certain price point, as well as trailing stop losses (TSL). A TSL is a stop loss you set at a certain price point, after which if the price increases the stop loss value is increased such that the distance between the current price and the stop loss price is maintained. If the price subsequently drops, the stop loss price remains at the higher price. Here’s an example for each type of stop loss.
Normal Stop Loss
- Buy stock at $100 and set stop loss at $80
- Price falls to $79.99, stock is sold
Trailing Stop Loss
- Buy stock at $100 and set trailing stop loss at $80
- Price moves up to $110, TSL is now set at $90
- Price drops to $89.99, stock is sold
What’s the benefit? What’s the drawback?
What are the benefits and drawbacks of Stop Losses?
The benefits are that you can limit your loss, or even protect a profit to some degree. If you have a large number of positions, or aren’t able to watch the market every minute of every day the automation provided by stop losses should alleviate some of the stress involved in trading.
The main drawbacks are that you don’t make as much profit as could if you’d manually closed a position (although timing the market manually is risky in itself), and that in highly volatile markets you could be stopped out of a position that is actually on it’s way up in the medium- and long-term.
A Few Stop Loss Strategy Examples
There are many times when you might want to use a stop loss, as well as particular ways to use them. Here are a few example strategies that you can use as a template for your own trading — if you have any that you’d like to share please let me know!
1. Bull market, company with strong fundamentals, low or no leverage, no immediate risk apparent
If the future is bright for the market and the company I would use a fixed stop loss 20% or more from the opening price. Here we’re willing to let the price drop because we believe it will recover and exceed the opening price. For volatile stocks e.g. AMD or Square, I often set my stop loss much further than 20% from the opening price.
2. Looking to take advantage of news that will hugely affect price, AND/OR you’re using high-leverage
I really advise that you never use high-leverage, but if you must or there is some event that will hugely impact price then I would advise a super tight stop loss e.g. 5% or even less. If you believe the price will continue in the direction you expect after the news event then you may want to use a fixed stop-loss. If not consider a TSL.
3. Volatile and skittish market, company has good fundamentals
In a volatile market you’ll need to realise profits more often than otherwise, as well as preventing your positions from running too far into the red just in case the market does turn on you. In this scenario I would usually initiate a position with a static stop loss no further than 15% from opening price, and once the position is more than 8–10% in profit I will often set a new TSL at the break-even price point. In this way if the price immediately turns against me the position has cost me nothing except fees, and if it continues up the stop loss price is now profitable.
4. Market correction, or bear market
In either of these scenarios you will be shorting an asset. Shorting is more risky than going long for several reasons:
- An asset can only ever lose 100% of it’s value i.e. you can make a max of 100% on a short (with no leverage of course), whereas you can lose ∞%
- If you’re trading stocks, the entire company will be trying to succeed i.e. there are teams of people trying to make the company better and increase the stock price. In shorting the stock you are betting that all of these people will fail, at least for a while.
I will not go into depth on shorting, but the above should highlight that it is risky business and therefore a stop loss strategy is even more important. I would always keep a SL on a short much tighter than on a long position, the exact “size” of which would depend on the volatility of the market, the volatility of the instrument and my appetite for risk at that point in time.
A stop loss strategy should always be developed within the context of your wider investment plan. Have a plan, write it down, read it every week to ensure you are inline with your plan and if necessary make adjustments.
