A stop-loss is a predetermined price at which you will sell a stock if it moves against you. Its purpose is to limit losses and protect your investment capital. While many new investors simply choose a percentage such as 10% below the purchase price, experienced investors understand that an effective stop-loss is based on the stock’s behaviour, market conditions, and their own investment strategy. Choosing the right stop-loss requires careful planning because placing it too close to the current price may result in being stopped out during normal market fluctuations, while placing it too far away may expose you to larger losses than you intended.

Here are the most common approaches.

1.Support level (most common for technical traders)

One of the most common methods used by investors is to place the stop-loss just below a support level. Support is an area where a stock has repeatedly stopped falling and started rising again because buyers have entered the market. For example, if a stock has fallen to $45 on several occasions before recovering, that price becomes an important support level. Instead of placing your stop exactly at $45, you might place it at $44.50 or $44.75. This allows the stock some room to fluctuate naturally while still protecting you if the price genuinely breaks below support. If the stock falls through this level with strong selling pressure, it often suggests that market sentiment has changed and that further declines may follow.

Place the stop just below a key support level.

For example:

• You buy at $50.
• The stock has repeatedly bounced around $45.
• You place your stop at $44.50 or $44.75.

If the price breaks below support, it may indicate the trend has changed.

2.Percentage stop

Choose a fixed percentage based on your risk tolerance.

Examples:

• Conservative: 5–8%
• Moderate: 10–15%
• Aggressive or volatile stocks: 15–20%

Example:

• Buy at $100
• 10% stop-loss = $90

This method is simple, but it doesn’t account for how volatile the stock normally is.

3.Volatility-based stop

 Many experienced traders use a technical indicator known as the Average True Range (ATR) to measure a stock’s typical daily movement. The ATR calculates the average distance the stock moves over a given period, usually fourteen trading days. Suppose a stock is trading at $80 and has an ATR of $2. This means that on an average day, the price moves approximately $2. Placing a stop only $1 below the purchase price would likely result in the position being closed simply because of ordinary market movement. Instead, an investor may place the stop two or three times the ATR below the purchase price, giving the stock enough room to fluctuate while still protecting against a significant decline. Use the stock’s normal daily price movement.

Example:

• Buy at $80
• ATR = $2
• Stop = 2 × ATR below entry
• Stop-loss = $76

This gives more room to stocks that naturally have larger price swings.

4.Trailing stop

As your investment becomes profitable, you should also consider adjusting your stop-loss. Many investors use a trailing stop-loss, which automatically moves higher as the stock price rises but never moves lower if the stock falls. For example, if you purchase a stock at $100 with a trailing stop of 15% and the share price later increases to $140, your stop-loss rises to approximately $119. If the stock continues climbing, the stop continues moving upward, helping to lock in profits while still allowing the stock room to grow. If the stock eventually reverses and falls to the trailing stop, your position is sold, protecting a significant portion of your gains.

Example:

• Buy at $100
• 15% trailing stop
• Stock rises to $140
• Stop moves up to $119
• If the stock falls to $119, you exit.

This can help protect gains while allowing room for the stock to continue rising.

5.Time Horizon

Your investment time horizon also affects where your stop-loss should be placed. A short-term trader who intends to hold a stock for only a few days or weeks generally uses tighter stop-losses because they want to minimise losses quickly if the trade does not work. In contrast, a long-term investor who intends to hold a quality company for many years may accept larger temporary price declines because they are focused on the company’s long-term growth rather than short-term market fluctuations. Many long-term investors choose not to use automatic stop-loss orders at all, instead selling only if the company’s financial performance weakens, its competitive advantage disappears, or the original investment thesis is no longer valid.

Lauren Hua is a private client adviser at Fairmont Equities.

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