Introduction
A stop-loss order is an automatic sell instruction you place with your broker to exit a stock if its price falls to a level you specify. It’s a fundamental risk management tool that helps you limit losses without needing to watch the market every minute.
Why does this matter to you? If a trade goes wrong, emotions can make you hesitate and hold a falling stock for too long. A stop-loss lets your plan run without emotion, so you won’t be left with large, unexpected losses.
In this article you’ll learn what stop-loss orders are, how to set them, when a trailing stop makes sense, and real examples using familiar tickers like $AAPL and $TSLA. You’ll also see common mistakes to avoid and clear, actionable steps you can use right away. Ready to get clearer control of downside risk?
Key Takeaways
- Stop-loss orders automatically sell a stock at a set price to limit downside and remove emotion from decisions.
- Decide stop levels using percentage drops, technical support, or volatility, then combine with position sizing so you risk only a small portion of your account per trade.
- Trailing stops move with price gains and lock in profits, but they can be triggered by normal volatility if placed too tight.
- Common mistakes include setting stops too close, removing stops after a loss, or ignoring position sizing. Use a written plan to avoid these errors.
- Stop-losses are not perfect guarantees, but they’re a simple, effective tool for new traders to manage risk.
What Is a Stop-Loss Order?
A stop-loss order tells your broker to sell your shares when the price reaches a specific level. The main goal is to cap the loss you’ll take on a trade. You choose the exit price in advance so you don’t have to make a split-second decision while prices are moving.
There are two common types of stop orders. A stop-market order converts to a market order once the stop price is hit, which means execution is likely but the exact sale price can differ from the stop. A stop-limit order converts to a limit order at your specified price, which gives price control but risks not executing if the stock gaps lower.
Key definitions
- Stop price: The trigger price that activates the sell instruction.
- Stop-market order: Becomes a market order when the stop is hit.
- Stop-limit order: Becomes a limit order asking to sell at the limit price or better after the stop is hit.
How to Choose a Stop-Loss Level
There’s no single right answer for every stock and trader, but a systematic approach helps. You should combine a stop level with position sizing rules so you never risk more than a small percentage of your account on any single trade.
Three practical methods for choosing a stop level are percentage-based, volatility-based, and technical support-based. Pick one that fits your trading time frame and the stock’s typical movement.
1. Percentage-based stop
This is simple and common for beginners. You might set a stop at 5% to 15% below your purchase price depending on how volatile the stock is. For a conservative approach, keep stops toward the lower end. For high-volatility names like $TSLA you may use wider stops, otherwise you’ll get stopped out by normal swings.
2. Volatility-based stop
Volatility-based stops use a measure such as Average True Range, or ATR, to set a stop that respects how much the stock typically moves. For example, you might set a stop at 1.5 times the ATR below entry. This reduces the chance of being stopped out by routine fluctuations.
3. Technical support stop
Look for recent support levels on the chart and place your stop just below that area. If $AAPL recently bounced at $130, a stop at $128 might be sensible. This method ties your stop to market structure and can be more intuitive for price-based traders.
Position Sizing: The Other Half of Risk Control
A stop-loss on its own doesn’t control how much you lose in dollar terms. That depends on how many shares you own. Position sizing ensures your stop translates into an acceptable dollar risk.
A common rule is to risk 1% to 2% of your account on any single trade. That means if you have a $10,000 account and you’re willing to risk 1%, you’ll accept a $100 loss on that trade. If your stop is $5 below your entry, you’d buy 20 shares so the $5 move equals $100 risk.
- Account value: $10,000
- Risk per trade: 1% = $100
- Stop distance: $5
- Position size: $100 / $5 = 20 shares
Using position sizing with a stop-loss keeps your portfolio safe from a single bad trade. You’ll sleep better at night, and you’ll be able to trade again after a loss.
Trailing Stops: Protect Gains While You Ride Winners
A trailing stop moves your stop price up as the stock rises. It’s a way to lock in profits while giving the position room to run. You can set trailing stops as a fixed dollar amount or a percentage below the highest price reached since you entered.
For example, if you buy $AMZN at $120 and set a 10% trailing stop, the stop sits at $108. If the stock climbs to $150, the trailing stop moves to $135. If the stock then falls from $150 to $135, your stop is hit and you exit with a profit.
Trailing stops are helpful when you want to stay in a winning trade but avoid turning a big gain into a loss. Be aware though, normal volatility can trigger a trailing stop if it’s too tight.
Real-World Examples
Concrete examples help make this real. Below are simple, realistic scenarios using round numbers so you can practice the calculation yourself.
Example 1: Percentage stop with position sizing
You decide to buy 50 shares of $AAPL at $150. You want to risk no more than 1% of your $20,000 account, which is $200. The percentage stop you choose is 6% below entry, or $141.
- Stop distance: $150 - $141 = $9
- Maximum risk: $200
- Shares to buy: $200 / $9 ≈ 22 shares
You adjust and buy 22 shares, not 50. This keeps your dollar risk at around $198 if the stop is hit.
Example 2: Trailing stop to protect a winner
You buy $TSLA at $200 and set a 12% trailing stop. The stock rises to $280 and the trailing stop moves to $246. If the stock reverses and hits $246, you exit and preserve a profit even though the stock fell from its peak.
Example 3: Stop-limit trade caution
You buy a small biotech stock at $8 and set a stop-limit with a stop at $6 and a limit at $5.50 to avoid selling below $5.50. If the stock gaps down to $4 after bad news, the stop will trigger a limit order at $5.50 but it will never execute. You may be left holding a large loss. That shows the tradeoff between execution certainty and price control.
When Not to Use a Stop-Loss
Stop-losses are useful most of the time, but there are situations where you might avoid them. If you own a stock for very long-term reasons and you expect short-term volatility, you might prefer to monitor the position instead. Another example is illiquid penny stocks where order execution can be unpredictable.
Still, even long-term investors often use mental stop levels or review their holdings periodically so a sudden collapse doesn’t surprise them. The key is to have a plan that matches your time horizon and risk tolerance.
Common Mistakes to Avoid
- Placing stops too close: If your stop is narrower than normal price swings, you’ll get stopped out often. Avoid this by using volatility-based stops or slightly wider percentage stops.
- Moving or removing the stop after a loss: Letting a losing trade run after moving your stop farther away increases risk. Set rules up front and stick to them to avoid emotional decisions.
- Ignoring position sizing: A stop without size control can still cause a big dollar loss. Always calculate how many shares match your risk per trade.
- Relying on stop-limit orders during fast-moving news: Stop-limit orders can fail if the stock gaps below the limit price. Know the tradeoffs between execution risk and price certainty.
- Using one-size-fits-all stops: Volatility and time horizons differ across stocks. Adjust stop methods for each trade rather than using the same percentage for every ticker.
FAQ
Q: When should I use a stop-market vs a stop-limit order?
A: Use a stop-market if execution certainty matters and you’re willing to accept a potentially worse price. Use a stop-limit if you must avoid selling below a certain price, but accept the risk the order may not fill if the stock gaps through your limit.
Q: How wide should I set a trailing stop?
A: There’s no fixed width, but common ranges are 5% to 20% depending on the stock’s volatility. Tighter stops lock in gains earlier but may trigger on normal swings. Consider using ATR to set a volatility-aware trailing stop.
Q: Will a stop-loss protect me during overnight gaps?
A: Not always. A stop-market triggers when the price hits the stop, but if the stock gaps below the stop at the open, the execution price could be much lower. Stop-limit orders won’t guarantee a sale in those situations.
Q: Should I use stop-losses for every trade?
A: For most short-term and many medium-term trades, yes. Stops are a simple way to manage risk. For very long-term positions you might use different monitoring or mental stops, but you should still have a plan for limiting extreme downside.
Bottom Line
Stop-loss orders are a core risk management tool that help you limit losses, protect gains with trailing stops, and remove emotion from trading decisions. They work best when combined with position sizing and a clear trading plan.
Start by deciding how much of your account you’ll risk per trade and choose a stop method that matches the stock’s volatility and your time frame. Practice the math on paper or a simulator so you feel comfortable before risking real money. At the end of the day, stop-losses won’t remove all risk, but they’ll give you predictable, controlled exposure and protect your ability to trade another day.
