“What is a good stop-loss percentage?” is a question that all traders must know. As you know, setting a good stop-loss is integral to the long-term success of a trader. In fact, put aside practical trading, traders shouldn’t even think about trading without it. Therefore, if you want to achieve success and are serious about the trading journey, they forget about starting trading before knowing “what is a good stop-loss percentage?”
As knowing a good stop-loss percentage is a prerequisite to safe trading, we decided to help you in this aspect of trading as well. Therefore, we are going to explore what is a good stop-loss percentage. Let’s dive deep and learn all about stop-loss orders and a good stop-loss percentage.
What are stop-loss orders?
Stop-loss orders are order types that automatically close an open trade when the price reaches a specified level. In simplest terms, traders predefine a certain price level and when the price of a financial instrument goes above or below that level, stop-loss orders close their open positions. That means stop-losses enable traders to close losing trades earlier and prevent losses from growing too much.
All trading platforms offer stop-loss orders to empower traders to trade without risking too much capital. So, these are risk management tools. Let’s try to understand how stop-losses help traders through an example.
Suppose that you are looking to go long on a company’s stock. Let’s say that the stock of that company is currently trading at $25 per share. Now, you want to keep your position open but also want to manage risk exposure. Here stop-loss order comes into the picture. Yes, you will manage risk by using a stop-loss order. Let’s say that you want to close your position if the price goes below $19. So, you will set a stop-loss at $18.99.
The importance of stop-loss orders
The importance of stop-loss orders cannot be overemphasized as they help in risk management. They are very important tools that automatically close a losing trade and help in preventing losses if a trade goes against you. That means, they help in avoiding too much loss, especially if you are trading in an excessively volatile market.
Conversely, if you don’t set proper stop-loss orders, the odds of losing a significant portion of your capital increase, especially in the case of a large position getting uncontrollable.
Simply put, setting proper stop-loss orders leads you to success in trading. Is getting profits more important than controlling risk? No, because proper risk management enables you to stay in the game for the long term. And for that, stop-loss orders are of paramount importance as they help you control risk and protect your capital.
Additionally, stop-losses also help in other risk management techniques. For example, they help in deciding position size, how much to risk on a single trade, how much to risk for a potential single dollar profit, and much more. Simply put, stop-loss should be a key part of your overall trading strategies.
So, you are well aware of the importance of stop-loss orders by now. Now, it is time to move to our main question “what is a good stop-loss percentage?”
What is a good stop-loss percentage?
First things first, there is no absolute figure as an answer to the question “what is a good stop-loss percentage”. Firstly, it is a personal decision as only you decide how much you are willing to risk on your trade. Secondly, there are two important variables that you need to consider. The first variable is position size and the second is the chances of winning your trade.
Moreover, if we talk about a good stop-loss percentage, there are two ways to choose it. Firstly, you can decide the stop-loss percentage on the basis of the price movement percentage. Secondly, you can decide on the basis of the position size – total capital at risk.
What is a good stop-loss percentage? Understanding through examples
Let’s suppose that you have $10,000 in your trading account. You have invested $2,000 in the stock of a company and that is 20% of your capital. The current stock price of that company is $20 per share. Now, there are two strategies to set a stop-loss percentage.
The first one is to choose on the basis of stock price movement. Let’s say that you want to exit your position if the stock price falls by 10%. So, you will set a stop-loss of $18 ($20 × 10%).
The second one is to decide on the basis of your position size. Let’s say that you don’t want to risk more than 5% of your capital. In this case, your stop-loss will be $100 ($2000 × 5%).
What is a good stop-loss percentage? Top tips
Many experts and financial advisers may propose a hard and fast rule. For example, they may suggest a stop-loss below a 10% swing. That means you will set a stop-loss at $90 on a $100 investment. However, it is important to note that there isn’t a hard and fast rule. As we have mentioned earlier, it is entirely up to your risk appetite. It is a personal decision to decide how much you want to risk on a trade. However, there are certain things that you should consider. Here are a few tips you can follow.
1. Stop-loss percentage on the basis of price movement percentage and capital at risk percentage are good techniques for fairly big accounts. However, if you don’t have enough capital, you should never risk more than 1 to 2% of your capital.
2. If your position size is 100% of your total trading capital, you should go with 1 to 2% of your total capital.
3. A position size of 50% of the trading capital means you can go with 2 to 4% of your capital at risk to set stop-loss. It will maintain your total stop-loss to 1 to 2% of your entire capital.
4. Similarly, if your position size is 25% of your total trading capital, you should go with 4 to 8% of your capital at risk on each trade. Thus, this strategy will also maintain your total stop-loss to 1 to 2% of your entire capital.
5. Again, if your position size is 10% of your total trading capital, you should go with 8 to 12% of your capital at risk on each trade. As a result, you will keep your total stop-loss to 1 to 2% of your entire capital.
6. It is also important to note that keeping your stop-loss wide enough is important. This is because a wide stop-loss gives price room for normal fluctuations, especially if you are confident of the success of the trade.
7. Finally, it is also crucial never to neglect your chosen risk/reward ratio. It is important to note that a risk/reward ratio of 1:2 or 1:3 opens the door to success in trading. Therefore, it is important to keep it in mind when deciding on your stop-loss percentage.
“What is a good stop-loss percentage?” is a question that has no absolute answer. It depends on your personal risk appetite and a few other factors. Given the importance of stop-losses, it is important to trade with stop-losses. However, where you want to set stop losses depends on you. The two prominent strategies include set stop-loss on the basis of price fluctuations or on the basis of the percentage of capital on risk. Moreover, if you have a small trading account then following the tips mentioned earlier will set you on an easier path to profitable trading.