How to Set Stop Loss Levels: Complete Guide

A stop loss is your safety net in trading. It automatically exits a position when price moves against you by a predetermined amount. Setting stop losses correctly is both an art and a science - too tight and you get stopped out of good trades, too wide and you take unnecessary losses. This guide covers multiple methods for finding the right stop loss levels.

Why Stop Losses Are Non-Negotiable

Stop losses serve three critical functions:

• Capital Preservation: Prevent catastrophic losses from any single trade
• Emotional Control: Remove the need to make decisions under stress
• Risk Quantification: Allow precise position sizing when risk is defined

Method 1: Support and Resistance Stops

This is the most popular method among technical traders. Place stops just beyond key support (for longs) or resistance (for shorts) levels.

For Long Positions

• Identify the nearest support level below your entry
• Place stop slightly below that support (allow some buffer)
• If support breaks, your trade thesis is invalid

For Short Positions

• Identify the nearest resistance level above your entry
• Place stop slightly above that resistance
• If resistance breaks, your short thesis is invalid

Example

Stock XYZ is trading at $52. You identify strong support at $48 from multiple previous bounces. Place your stop at $47.50, giving a small buffer below support.

• Entry: $52
• Stop: $47.50
• Risk per share: $4.50

Method 2: ATR-Based Stops

The Average True Range (ATR) measures a stock's typical daily volatility. ATR-based stops adapt to each stock's natural movement.

Example

• Stock ABC at $100
• 14-day ATR: $3.00
• Using 2x ATR multiplier: Stop = $100 - ($3 x 2) = $94

Advantages:

• Automatically adjusts for volatility
• Wide enough to avoid normal price noise
• Consistent methodology across different stocks

Method 3: Percentage-Based Stops

Simple but less sophisticated - set stops at a fixed percentage from entry.

• Conservative: 3-5% from entry
• Moderate: 5-8% from entry
• Aggressive: 8-12% from entry

Example

Buy stock at $50 with 5% stop = $47.50 stop level

Limitations:

• Does not account for the stock's natural volatility
• May not align with technical levels
• Better suited for longer-term positions

Method 4: Moving Average Stops

Use moving averages as dynamic stop levels. This works well for trend-following strategies.

Common Approaches

• 20-day MA: For swing trades, exit if price closes below
• 50-day MA: For position trades, key support/resistance
• 200-day MA: For long-term investing, major trend level

Example

You buy a stock that is above its 20-day moving average. Your stop is a close below the 20-day MA. As the stock rises, the MA rises too, protecting more of your profit.

Method 5: Chart Pattern Stops

When trading chart patterns, place stops where the pattern would be invalidated:

• Breakout trades: Stop below the breakout level
• Head and shoulders: Stop above the right shoulder
• Double bottom: Stop below the pattern low
• Triangles: Stop on the opposite side of the formation

Where NOT to Place Stops

At Obvious Round Numbers

Everyone places stops at $50, $100, etc. Market makers know this. Place stops slightly below round numbers (e.g., $49.75 instead of $50).

At Exact Support/Resistance

Support and resistance are zones, not exact prices. Allow a buffer for price to briefly pierce these levels without triggering your stop.

Too Tight

Stops that are within normal daily range will get hit by noise. Use ATR to ensure your stop is beyond typical fluctuation.

At Arbitrary Levels

"I do not want to lose more than $200" is not a valid stop level. Stops should be at prices where your analysis is proven wrong.

Trailing Stops

Trailing stops move with the price to lock in profits while letting winners run.

ATR Trailing Stop

Trail the stop at 2x ATR below the highest high since entry. As price makes new highs, the stop moves up but never down.

Percentage Trailing Stop

Trail the stop at a fixed percentage (e.g., 10%) below the highest price. Simple but effective for trending markets.

Breakeven Stop

Once price moves a certain amount in your favor, move the stop to breakeven. This creates a "free trade" with no risk of loss.

Mental Stops vs. Hard Stops

Hard Stops (Recommended)

Actual stop orders placed with your broker. Execute automatically regardless of your emotional state.

Mental Stops (Risky)

You plan to exit at a certain level but do not place an actual order. Problems:

• Easy to rationalize not exiting when level is hit
• May not be watching when stop is triggered
• Emotions interfere with execution

Stop Loss Checklist

Before placing a stop, verify:

• Is the stop at a level where your trade thesis is invalidated?
• Is it outside normal daily price range (check ATR)?
• Is it below support (longs) or above resistance (shorts)?
• Is it not at an obvious round number?
• Does the stop distance allow proper position sizing?
• Is your risk-reward ratio still acceptable with this stop?

Handling Gap Risk

Stocks can gap past your stop loss on news or earnings. Strategies:

• Avoid holding through binary events (earnings, FDA decisions)
• Use smaller position sizes when gap risk is elevated
• Use options for defined risk when holding through events
• Accept that gaps happen and factor them into overall risk management

Summary

Stop losses are essential for survival in trading. Place stops at technical levels where your trade thesis would be proven wrong - just below support for longs, just above resistance for shorts. Use ATR to ensure stops account for normal volatility. Avoid obvious round numbers and arbitrary price levels. Consider trailing stops to protect profits on winning trades. Always use hard stops rather than mental stops. The goal is not to never get stopped out - it is to keep losses small and give winning trades room to develop.

Learn more: position sizing with stop losses and risk-reward ratio explained.