Every investment has a scenario in which it goes wrong. A stop loss is the decision, taken before buying, about what you will do in that scenario. It does not make a bad trade good; it keeps a bad trade from becoming a disaster.
What a stop loss is
A stop loss is a price level below your purchase price at which you will sell if the stock gets there. In practice it is usually an order left with the broker: "if the price falls to X, sell".
Its value is not the order itself but the decision made in advance. Deciding where to get out while you are calm is much easier than deciding it while the position is falling and you are hoping it will come back.
The three most common types
1. Fixed percentage stop
Sell if the price falls a set percentage, for example 8% or 10%, below the purchase price.
- For: simple, the same for every stock.
- Against: it ignores how much each stock usually moves. A 5% drop is a normal week for a volatile technology company and a big event for a utility.
2. Volatility stop (ATR)
The distance to the stop is a multiple of the stock's average daily range (the ATR). Nervous stocks get a wider stop and calm stocks a tighter one.
- For: it adapts to each stock, so ordinary noise is less likely to throw you out.
- Against: in very volatile stocks the stop can end up far away, so it needs a maximum. We explain the ATR in The ATR: How Much a Stock Moves.
3. Trailing stop
The stop rises with the price and never goes down. If the stock climbs, the stop climbs behind it; if the stock turns, the stop stays where it was and closes the position.
- For: it protects part of the gains already made.
- Against: if it follows too closely, a normal pullback closes a position that was still working.
- 1Buy.
- 2A normal dip: it stays above the volatility stop, set at 2.5 times the ATR.
- 3The trailing stop has risen with the price and closes the position with part of the gain.
Where to place a stop
There is no perfect level, but there are better and worse ways to choose it:
1. Far enough to survive normal noise. If the stop sits inside the stock's ordinary daily range, it will be hit by chance, not because the idea was wrong.
2. Close enough to keep the loss acceptable. A stop at -40% protects very little.
3. Decided before buying. Moving the stop down when the price approaches it turns a plan into hope.
4. Consistent with the position size. The loss if the stop is hit is the distance to the stop times the money invested. If that amount is too much for you, the answer is a smaller position, not a wider stop.
A stop is a level, not a guarantee
This is the most important point and the one most often forgotten.
If a company publishes bad news after the close, the next day it can open well below the stop. The stop order is then executed at the first available price, which can be much worse than the level you chose. This is called a gap.
So the real loss can be larger than the distance to the stop. It happens rarely, but it happens, and it is part of the risk of owning any stock.
How our signals set their stops
Every signal publishes its exit rules before it opens. These are the stop rules:
Bounce
- A volatility stop (ATR) fixed on the day of entry, never further than -10% from the published buy price.
- It applies only during the first 10 sessions: a rebound that has not developed by then is handled by the other exits.
- A trailing stop that starts working once the position is +0.5% in profit.
Impulse
- A volatility stop (ATR) fixed on the day of entry, never further than -15%, during the first 20 sessions.
- A fixed floor at -20%, active for the whole life of the position.
- A trailing stop that starts working from +3% in profit.
The price stops act during the session: if the price touches them, the position closes at the stop, and if the stock opens below them it closes at the opening price. The trailing stop and the other exits (a close below the 200-session average, the time limits) are evaluated at the close and executed at the next open.
The signal page shows the stop in force at every moment, and the full exit rules are on the methodology page. The guide From Signal to Exit follows a position from start to finish.
In short
- A stop loss is the exit decided before entering.
- Fixed stops are simple; volatility stops adapt to each stock; trailing stops protect gains.
- Place it outside normal noise and size the position so that the loss is acceptable.
- A stop is a level, not a guarantee: a gap can execute it lower.
This content is for educational purposes only and does not constitute financial advice. Past performance does not guarantee future results.