Calculating Stop Loss: A Complete Guide

Stop-loss is an order type investors and traders use to limit their losses and reduce risk during intraday trading. These orders contain pre-determined instructions to purchase or sell an asset at the market when it hits a specific/set price known as the stop price. It is very fundamental when it comes to intraday trading.

 

To effectively use stop loss, investors must know what stop loss is and how to calculate it. Explore how to calculate stop loss for intra-day trading.

 

What Factors are Considered when Calculating Stop Loss?

An investor has to be clear about two aspects to know how to calculate the stop loss. First, how much risk are you willing and able to accept? Second, where should technical levels be set for the stop-loss? Now let’s understand 3 ways of stop loss calculations:

 

1. Percentage Method

The first way of determining the stop loss is referred to as the Percentage Method. This is widely used by intraday traders to set stop losses. Here, the permissible loss is one that is stated or calculated in terms of a percentage.

For instance, if you entered a long RIL at Rs. 2300 and placed a stop loss at 0.8%, then your stop loss for the buy position will be set at Rs. 18 lower, i.e., at Rs. 2282. That is the maximum you lose if a decided trade goes wrong. However, when setting stop losses, it is also wise to consider the brokerage and statutory costs.

 

2. Technical Support

The second approach of calculating the stop loss is known as Technical Support/Technical Resistance. Many of the experienced intraday traders employ this technique but it requires the ability to read charts with consummate ease. For buy positions, the stop loss is placed below the support levels and for sell positions, the stop loss is set above the resistance levels.

 

3. Moving Averages Method

The last technique to apply when setting the stop loss is the Moving Averages Method. You first find out a long-term moving average, which will serve as your reference point. This is the time that you get to decide whether to go for simple moving averages (SMA) or exponential moving averages (EMA).

After identifying and freezing the moving average, set your stop losses slightly below the moving average for bull runs and slightly above the moving average for bear runs.

 

How to Set a Stop Loss?

This is one of the most critical choices that an intraday trader is likely to make. Stop-loss decides how much the trader is willing to lose in a given trade in case the stock goes down. It is helpful for investors and traders because the stock market is very dynamic, and the stock prices always fluctuate.

Not all traders in the world gain returns in all the trade they undertake. This is where a stop-loss order comes in handy to keep losses as low as possible. It is essential to utilize stop losses as a protective measure for risk. Stop-loss also defines the limit of risk or the loss that one can afford and which will not significantly erode the capital.

Volume and volatility are important when trading intraday, as is risk-reward. It is of no use in making a stop loss at 1% and a target price of 1%. The golden rule here is to have a ratio of 2:1. 5:1 or 3:1 when engaging in intraday trading.

If one sets the stop loss level too far away, there is a high chance of making big losses in case the stock price goes against your expected direction. On the other hand, if you set the stop loss level close to the buying price or the selling price, these stop losses may start working with the slightest volatility.

 

Conclusion

Managing risk makes it important for every trader to understand the basics of stop-loss calculations. Thus, it is necessary to adapt the stop loss technique according to your risk profile, whether you prefer the percent method for systematic, the support method for technicality, or the moving averages method for the trends. By mastering the ability to calculate stop loss, a trader could comfortably navigate through the markets with the track.