How to Set Up Stop Loss in Stock Trading?

What is Stop Loss?

A Stop Loss is a predetermined price level at which I choose to exit a position to limit potential losses. By setting a Stop Loss, I aim to protect my capital as much as possible. Think of it as a life saver—it's not merely about booking a loss; it's about effectively managing risk.

Why is Setting Up a Stop Loss So Important? 🌴

It's crucial to understand that only about 20% of traders use Stop Loss orders in their actual trades, and we know that only around 10% of traders are profitable in the long run. When I look at these successful traders, I notice they consistently employ Stop Loss strategies to safeguard their capital. Here’s why a Stop Loss is so important:

• Protects Equity or Capital: Helps limit losses.
• Prevents Account Washout: Keeps my trading account from depleting entirely.
• Encourages Accurate Trading: Promotes disciplined trading habits.
• Builds Strong Mental Psychology: Helps me stay calm in volatile markets.
• Facilitates Effective Money Management: Assists in handling sudden market reversals.
• Eases Evaluation of Trading Strategies: Allows me to assess my strategies more effectively.

A trader who knows when to exit is a well-informed trader.

How to Set a Stop Loss?

For Computer Users

If I'm trading on a platform like Zerodha, setting up a Stop Loss is straightforward. I can adjust it directly within the order window while placing my trade.

For App Users

If I'm using the Zerodha trading app, the process is quite similar. I simply look for the option to set a Stop Loss while placing my order.

Where to Put a Stop Loss?

Placing a Stop Loss is about identifying when a trade becomes invalid. This depends on my trading strategy. Let’s explore how to set Stop Loss for different trading styles.

Swing Trading Strategy 🧎‍♀️

For swing traders, I set the Stop Loss just below the nearest swing low. However, I must be cautious—this level may be hit in about 70% of cases due to Stop Loss hunters. To protect myself, I consider adding a few extra points to avoid getting stopped out too easily.

According to stock market expert Sunil Mingalini, placing the Stop Loss at the second swing can be safer, as it only triggers when market trends genuinely change. However, I need to account for my risk tolerance.

Non-Rounded Example: If the first swing price is ₹174.80, I add a few points like ₹0.13 or ₹0.17 to avoid rounded numbers.

Scalping Trading Strategy 🤞

For scalping, my Stop Loss should align with my chosen time frame. If I'm using a 5-minute chart, I set my Stop Loss accordingly. However, for 1-minute charts, I may need to make quick decisions, and I might not have time to set a Stop Loss after entering a trade.

Typically, scalpers place their Stop Loss near the close of the second or third candle while adding a few extra points to account for market fluctuations.

Positional Trading Strategy 🐱‍👤

In positional trading, the simplest approach is to set my Stop Loss at key support or resistance levels. Additionally, I add a few points to prevent Stop Loss hunting.

Other Techniques for Setting Stop Loss Levels:

• For sell trades, consider using Bollinger Bands' upper level (+2 standard deviations) and add some points.
• For buy trades, use the lower Bollinger Bands level (-2 standard deviations) and add some points.
• If I'm using Average True Range (ATR) for take profit, I can also apply it to set my Stop Loss levels.
• In pure price-action trading, I can set my Stop Loss at the nearest candle closing price.

Tip: If I’m ever in front of the screen and realize I’ve entered a wrong trade, I close it immediately. Don’t wait for my Stop Loss to be hit.

Summary

A Stop Loss is an essential tool for securing my capital in stock trading. I can set my Stop Loss levels based on my risk tolerance and trading strategies. It's crucial to always implement Stop Loss orders in my trading platform, not just in my mind, to avoid the pitfalls of emotional decision-making.