What is a stop loss? A plain-English guide for beginners

How a stop loss works

Say you buy a share at 100 and decide you are wrong if it falls to 95. You place a stop loss at 95. If the price reaches 95, your broker turns the order into a sale and the trade ends. You have lost about 5 per share, and no more, instead of watching it fall further.

For a trade that profits when the price falls (a short position), the stop sits above the entry price instead. The idea is the same: it marks the point where you accept the trade was a mistake.

Where do people put a stop loss?

There is no single correct place, but sensible stops are chosen before the trade, based on the market, not on how much money you feel like risking. Common methods:

• Below a recent low (or above a recent high for a short trade), because breaking it suggests the idea has failed.
• A multiple of the asset's normal daily movement, often measured with a tool called Average True Range, so the stop isn't triggered by ordinary noise.
• A fixed percentage of the price, which is simple but ignores how much the market usually moves.

Tie the stop to how much you risk

The stop's distance from your entry tells you how big the position can be. If you decide to risk 1% of your account on a trade and the stop is 5 away from your entry, you work out how many shares make a 5-per-share loss equal 1% of the account. This is called position sizing, and it matters more than most beginners expect. Our guide to risk and reward builds on it.

What a stop loss cannot do

A stop loss is not a guarantee. In a fast market or when prices jump overnight, your order can be filled at a worse price than you chose. This is called slippage, or a gap. A guaranteed stop (offered by some brokers for a fee) avoids it, but a normal stop does not.

A stop loss also won't stop you from taking too many trades or risking too much per trade. It is one tool inside a plan, not the plan.

Common beginner mistakes

These are the ones that cost new traders the most:

• Moving the stop further away because the price is getting close to it.
• Placing it so tight that normal movement triggers it every time.
• Having no stop at all and hoping the price comes back.

Practise it first

The best way to learn is to use stops on simulated money before real money is at stake. Finovo's practice account lets you place trades with a stop on simulated prices, so mistakes cost nothing.