A stop-loss order automatically sells a stock when it drops to a specified price. It's a risk management tool that limits potential losses without requiring constant monitoring.
You buy at $100 and set a 10% stop-loss at $90. If the stock drops to $90, it automatically sells. Your loss is capped at 10% (plus any gap risk).
Stop-losses protect against large losses but can trigger during normal volatility. A 7-10% stop on swing trades is common. For long-term holdings, wider stops (15-20%) or none at all may be better. Be aware of gap risk — the stock may open below your stop price. The key is matching your stop strategy to your trading style and the stock's volatility.
Not all stop-loss strategies are equal. Here's how the main approaches stack up based on backtesting research:
| Strategy | How It Works | Best For | Typical Setting |
|---|---|---|---|
| Fixed % | Set X% below purchase price | Day/swing trades | 7-10% |
| Trailing % | Moves up with highest price | Trending stocks | 15-20% |
| ATR-Based | 1-2x Average True Range below | Volatile stocks | 1.5-2x ATR |
| Technical Level | Below support or moving avg | Position trades | Varies by chart |
Professional traders use stop-losses to determine position size. The formula: Position Size = Risk Amount ÷ (Entry Price - Stop Price). For example, if you're willing to risk $500 (1% of a $50,000 account) and your entry is $100 with a stop at $93 ($7 risk per share): Position Size = $500 ÷ $7 = 71 shares ($7,100 position). This ensures you never lose more than your predetermined risk amount.
A standard stop-loss becomes a market order when triggered. If a stock closes at $50 and opens the next morning at $42 on bad earnings, your $45 stop triggers — but the sell executes at $42 or lower. You lose $8/share instead of the planned $5. This "gap risk" is unavoidable with regular stop orders. Stop-limit orders protect against bad fills but risk not executing at all if the stock gaps past your limit price.
💡 Pro Tip: The 2% Account Rule
Never risk more than 2% of your total account value on a single trade. On a $25,000 account, that's $500 max loss per trade. Combined with proper position sizing (risk ÷ stop distance = shares), this rule ensures you can survive a long losing streak. Even 10 consecutive losses only costs you 18% of your account — recoverable, not catastrophic.
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Try Position Size Calculator →What percentage should my stop-loss be?
Common stop-loss levels: 7-8% for swing trading, 15-20% for long-term investing. The key is setting stops based on support levels and volatility, not arbitrary percentages. A 5% stop on a volatile tech stock will trigger constantly from normal fluctuations, while 5% on a utility stock may be appropriate.
What is a trailing stop-loss?
A trailing stop moves up with the stock price but never moves down. If you set a 10% trailing stop on a stock at $100, it triggers at $90. If the stock rises to $150, the stop moves to $135. This locks in profits while giving the stock room to grow. Most brokerages offer trailing stops as an order type.
Do professional investors use stop-losses?
Most don't. Value investors like Buffett argue that if you've done your research, price drops are buying opportunities, not sell signals. Stop-losses can force you to sell at the worst time — during market panics when prices are irrationally low. However, traders and quantitative strategies frequently use stops as risk management.