Definition of Stop Loss
Stop loss as the name suggests is maximum loss a trader is willing to take in case stock does not behave in the way anticipated by the trader.
The goal of a trader is to trade to make profit. But stock does not always move in the direction anticipated by the trader. In such a case, trader starts loosing money and if the stock moves in negative direction at a fast pace then losses can go to a very large amount.
Therefore to limit the loss, a trader can place a stop loss that defines maximum loss the trader can take for the given trade.
How to determine stop loss price ? There are many simple theories of putting stop loss
1. A fixed percentage below the current price.
2. Half the profit target. If the stock price is 100 and profit expectation is 10 then stop loss is 95. OR
3. Simply follow your financial experts opinion.
Aforementioned theories do work but there can be better ways of putting stop loss like using technical analysis. Some of them are:
Keep stop loss of x percentage below important support level. This percent can be as low as 0.1% for intra day to 2-3% for swing trading to 10-15% for long term trading.
Support and resistance can be calculated by:
1. Drawing trendline.
2. Using Moving Average.
3. Bollinger Band.
4. Neck line of Head And Shoulder can be a good starting point.
5. Break out of Channel or other pattern.
6. In swing trading the point where swing has started.
This is not an exhaustive list. But are mentioned here to give you some idea.
When are stop loss triggered often ?
In volatile market stop loss get triggered often. Its best to avoid trading during this time In narrow trading, the stop loss are bound to get triggered. Avoid trading in this range.
How to use stop loss in trending market ? In trending market stop loss can be revised upwards (in case of long) as and when stock moves up. With this profit target can be huge but losses are limited and if the stock changes direction then your profit is not wiped out. This is called trailing stop loss.
The goal of the trade is to make money if the stock direction is favorable and limited loss if stock movement is against expectations.