Stop-Loss Strategies

Stop-losses are your safety net. They automatically exit losing trades before small losses become account-destroying disasters. [DEFINITION] Stop-Loss: A predetermined price level at which you exit a losing trade to limit potential losses. ### Why Stop-Losses Are Essential [KEY] The math is brutal: A 50% loss requires a 100% gain to break even. Cutting losses early is mathematically necessary. | Loss | Gain Needed to Recover | |------|----------------------| | 10% | 11% | | 25% | 33% | | 50% | 100% | | 75% | 300% | ### Types of Stop-Losses **1. Fixed Percentage Stop:** Exit if stock falls X% from entry. - Simple to implement - Doesn't account for volatility **2. Support-Based Stop:** Place stop below key support level. - Respects market structure - Requires chart analysis **3. ATR-Based Stop:** Set stop at entry minus ATR × multiplier. - Adjusts for volatility - Scientific approach [EXAMPLE] Entry at $100, ATR = $4, using 2x ATR stop: Stop = $100 - ($4 × 2) = $92 **4. Trailing Stop:** Stop moves up with price, locking in profits. - Stays X% or $X below highest price - Never moves down [TIP] Different situations call for different stops. Breakout trades might use tighter stops; pullback entries might need more room. ### Stop-Loss Placement **Good stop placement:** - Below meaningful support - Beyond normal volatility - At a level that invalidates your trade thesis **Bad stop placement:** - At obvious levels everyone uses (stop hunts) - Too tight (stopped out on noise) - Too wide (defeats purpose) [WARNING] Don't set mental stops ("I'll sell if it hits $95"). Use actual stop orders. In the moment, you won't sell. ### Hard Stop vs. Soft Stop **Hard stop:** Actual order in the market **Soft stop:** Price level where you'll manually evaluate Soft stops allow for judgment but require discipline. Most traders should use hard stops. ### Stop-Loss Execution Issues **Gap risk:** If a stock gaps through your stop, you execute at the gap price, not your stop. [EXAMPLE] Stop at $50, stock closes at $52, opens next day at $45 on bad news. You sell at $45, not $50. Stops don't guarantee your exit price. **Stop-limit vs. stop-market:** - Stop-market: Guaranteed execution, not guaranteed price - Stop-limit: Guaranteed price, not guaranteed execution ### When to Move Your Stop **Move stop UP:** - After position moves significantly in your favor - Never move below original (giving losing trade more room) **Never move stop DOWN:** - This is hoping, not trading - Exposes you to larger losses [EXERCISE] You enter a trade at $80 with an ATR of $3. You decide to use a 1.5 ATR stop. Where do you place your stop? If the stock rises to $90 (ATR still $3), where should a trailing stop using 1.5 ATR be? |ANSWER| Initial stop = $80 - ($3 × 1.5) = $75.50. After move to $90: Trailing stop = $90 - $4.50 = $85.50. Your stop moved from $75.50 to $85.50, locking in $5.50 of profit. [SCENARIO] You entered a swing trade at $100 with a stop at $95. The stock drops to $96, then rebounds to $98, then drops back to $95.01 and starts recovering. You feel relieved it didn't hit your stop. Should you move your stop lower now that you "almost got stopped out"? Absolutely not. Your stop was correctly placed—the stock honored it and bounced. If anything, this validates your stop placement. Moving it lower would only increase your risk. The near miss is not a sign to give the trade more room; it's a sign your analysis was good.