What is a Stop Loss?
Learn how to automatically protect yourself from devastating losses with stop loss orders.
Quick Answer
A stop loss is an automatic sell order that triggers when a stock drops to a specified price, limiting your loss. Think of it as an emergency exit. Example: You buy Tesla at $200. You set a stop loss at $180. If Tesla crashes to $180, your shares automatically sell, capping your loss at 10% ($20/share). Without a stop loss, the stock could drop to $150, losing you 25% ($50/share).
How Stop Loss Works: Visual Example
Step 1: You Buy
Buy 100 shares of Apple at $180
Total investment: $18,000
Step 2: Set Stop Loss
Place stop loss at $165 (8.3% below purchase)
Max loss: $1,500 (100 shares × $15)
Step 3: Stock Drops
Apple falls from $180 → $170 → $165
Stop loss is triggered!
Step 4: Automatic Sell
Your 100 shares automatically sell around $165
✓ Loss limited to $1,500 instead of potential $3,000+ if it kept falling
Why Stop Losses Are Critical
❌ Without Stop Loss (Real Example)
March 2020 COVID Crash:
Investor buys 100 shares of Boeing at $340
↓
Stock crashes to $95 in 3 weeks
↓
Loss: $24,500 (72% of investment gone!)
Investor held hoping for recovery, but devastating loss already locked in.
✓ With Stop Loss
Same Scenario with Protection:
Investor buys 100 shares of Boeing at $340
Sets stop loss at $306 (10% below)
↓
Stock drops, stop loss triggers at $306
↓
Loss: $3,400 (10% - painful but survivable)
Investor preserved $21,100 to reinvest when market stabilized!
Types of Stop Loss Orders
1. Stop-Market Order (Most Common)
When stop price is hit, becomes a market order (sells immediately at best available price).
Example: Set stop at $100
✓ Pro: Guarantees you'll exit the position
✗ Con: Might sell below $100 if price is moving fast (slippage)
2. Stop-Limit Order (More Control)
When stop price is hit, becomes a limit order (only sells at your limit price or better).
Example: Stop at $100, limit at $99
✓ Pro: Won't sell below $99 (price protection)
✗ Con: Might not sell at all if price gaps below $99
3. Trailing Stop Loss (Advanced)
Stop price automatically adjusts as stock price rises, locking in profits.
Example: Buy at $100, set 10% trailing stop
Stock rises to $150 → stop now at $135 (10% below $150)
Stock rises to $200 → stop now at $180 (10% below $200)
✓ Locks in gains automatically while letting winners run
How to Set Stop Loss Levels
Method 1: Percentage-Based (Simple)
Conservative: 5-8% below purchase
Good for stable blue-chip stocks
Moderate: 10-15% below purchase
Standard for most stocks
Aggressive: 20-25% below purchase
For volatile growth stocks, gives room to breathe
Method 2: Technical Levels (Advanced)
- •Below Support: Set stop just below key support level (e.g., $100 support → stop at $98)
- •Below Moving Average: Set stop below 50-day or 200-day MA
- •Recent Swing Low: Place stop below the lowest point of recent consolidation
Method 3: ATR-Based (Volatility Adjusted)
Use Average True Range (ATR) to account for stock's natural volatility.
Formula: Stop Loss = Entry Price - (2 × ATR)
This gives volatile stocks more room while keeping tight stops on stable stocks.
Stop Loss Mistakes to Avoid
🚩 Setting Stop Too Tight
Putting stop 2-3% below purchase on a volatile stock = getting stopped out by normal fluctuations. You'll exit positions prematurely, missing the eventual gains.
🚩 Never Using Stops
"I'll just watch it closely" doesn't work. Emotions take over, you rationalize holding, and a 10% loss becomes 50%. Professional traders ALWAYS use stops.
🚩 Moving Stop Lower
Stock hits your stop, but you cancel and move it lower hoping for recovery. This defeats the entire purpose. Honor your stops!
🚩 Using Same % for All Stocks
Tesla (high volatility) needs wider stop (20%) than Coca-Cola (low volatility, 5% stop). Adjust based on stock's personality.
🚩 Ignoring Gap Risk
Stocks can "gap down" (open way below previous close). Your $100 stop might fill at $90 if bad news hits overnight. Accept this risk or avoid holding through earnings.
Stop Loss Best Practices
- ✓Set it immediately: Place stop loss order as soon as you buy. Don't wait.
- ✓Risk 1-2% of portfolio per trade: If you have $10,000, risk max $100-200 per position
- ✓Adjust stops upward (trailing): Move stop up as stock rises to lock profits. Never move down.
- ✓Use stop-market for liquid stocks: Guarantees exit on Apple, Microsoft
- ✓Use stop-limit for illiquid stocks: Prevents terrible fills on low-volume stocks
- ✓Factor in volatility: More volatile = wider stop to avoid getting shaken out
Common Questions
Do professional traders use stop losses?
Yes, absolutely. Every professional risk management system includes stops. Warren Buffett doesn't use them because he's a long-term investor buying companies, not trading stocks. If you're actively trading, stops are essential.
Can market makers see my stop loss orders?
Stop loss orders sit on your broker's server until triggered (not visible to the market). However, large clusters of stops at round numbers ($100, $50) are predictable. Consider placing stops at odd numbers ($98.50).
What if the stock recovers right after my stop loss hits?
This happens. It's frustrating but part of trading. You protected yourself from unknown downside risk. You can always re-enter if conditions improve. Better safe than sorry—small losses are acceptable, big losses are not.
Should I use stops on long-term investments?
Depends. Buy-and-hold investors often don't use stops (they view dips as buying opportunities). But if you're unsure about a stock or it's speculative, a 25-30% stop can prevent catastrophic losses.
Key Takeaways
- ✓Stop loss automatically sells your stock if it drops to a specified price
- ✓Protects you from catastrophic losses—turns 50% losses into 10% losses
- ✓Set stops 5-25% below purchase depending on stock volatility
- ✓Trailing stops automatically lock in profits as stock rises
- ✓Professional traders always use stops—it's essential risk management