Stop Losses - the most difficult, least glamorous, most essential part of trading.
All of my posts are from a genuine experience or things that I am currently doing; Stop Losses are no different, but they're a bit special to me. Everybody speaks of "Risk Reduction" and "Money Management" but very few explain what this means or how to do it. And if you search for "trading tips" or similar, it's always memorising chart patterns and using novel strategies. Very few places do a good job of helping you reduce your losses when they happen...because they do happen...a hell of a lot more than I thought they would. I lost a stupid amount of money early on in my trading history because
  • I didn't realise how important Stop Losses were

  • When I finally realised, I didn't have the self-discipline to stick to them

I learnt the hard way, possibly the hardest way, about Stop Losses and I hope this post will help others avoid the same mistakes I made.

A good Stop Loss process will be unique to the trader that employs it, and not every trader/investor will use one. For example, a leveraged forex day-trader will have very different Stop Loss rules to a fundamental analyst looking to invest in early-stage growth stocks. I would classify myself as a short-term swing trader, relying primarily on technical signals, and my Stop Loss process reflects this. It may not be exactly what you're looking for but hopefully it will give you an idea or some inspiration.

My Stop Loss Rule
Figuring out where to put your Stop Losses is oddly difficult. You'd expect it to be quite intuitive but without adhering to strict rules it can become increasingly arbitrary and the value of failed trades can quickly snowball.
  • Never risk more than 2% of your investment capital in a single trade.

  • The Reward/Risk Ratio must be at least one.

  • I aim for positions that I believe will make me 10% in fewer than 30 calendar days.

The first rule above is fairly generic (but sensible) - it's a piece of advice I once read but have stuck with. The second two are pillars of my strategy that shape every trade I make, and given that my desired Reward for all positions is 10% then the maximum risk I can allow for any trade is also 10%. Combining all three gives me my Stop Loss Rule:
  • I cannot lose more than 2% of my capital or 10% of the position, whichever is smaller, in a single trade. But you don't have to risk the maximum amount.

I have $2,000 trading capital:

Example A
2% of capital = $40
Open a Position of $300
10% of position = $30
Stop Loss cannot exceed $30

Example B
2% of capital = $40
Open a Position of $1,000
10% of position = $100
Stop Loss cannot exceed $40

Real Trade Examples
4th October 2021 12:43 BST
Bought 3 shares of $NKE @ $146.31 = $438.93 position total
2% of capital = $40
10% of position = $43.893
Maximum permitted loss = $40 (smaller of the two)
Maximum Stop Loss = $146.31 - ($40/3 shares) = $132.98
I entered this trade anticipating a bounce from the red dashed line. If it broke through the line, it would have invalidated the reason for entering, so a Stop Loss was set at $141.99 to allow a little wiggle room. It's much tighter than the maximum permitted of $132.98 but there was no reason to expose myself to unnecessary losses.
Fortunately, the trade bounced as expected and closed on my Take Profit order rather than my Stop Loss.
1st October 2021 20:49 BST
Bought 10 shares of $ASO @ $40.02 = $400.20 position total
2% of capital = $40
10% of position = $40.02
Maximum permitted loss = $40 (smaller of the two)
Maximum Stop Loss = $40.02 - ($40/10 shares) = $36.02
Similar to the previous trade, I was expecting an immediate bounce back up following the rejection candle from the support. My Stop Loss was exceptionally tight here at $39.68 - enough to allow wiggle room again but if the price reached lower it would have invalidated the entry criteria of the trade. The trade closed the very next day which was disappointing but, looking at the chart today (17th October), justified.
$ASO has netted barely 1% in the following two weeks since the trade closed and the capital has since been put to better use.

12th October 2021 20:41 BST
Bought 18 shares of $APA @ $24.64 = $443.52 position total
2% of capital = $40
10% of position = $44.352
Maximum permitted loss = $40 (smaller of the two)
Maximum Stop Loss = $24.64 - ($40/18 shares) = $22.42
$APA had just registered its second close above a key resistance level, pulling back slightly but not unexpectedly so, and this met several entry criteria. At the time I didn't expect much more of a pullback so set a Stop Loss of $24 - much tighter than the maximum permissible.
The trade closed the very next day, 19 minutes after open, but the stock actually regained ground very quickly and has almost hit my Original Take Profit (OTP) target of $27.11. Below is what the chart looks like as of right now:
If my Stop Loss was at the maximum permitted, the trade would be still be open and hitting $27.11 looks very achievable - this could have been a profitable trade. It's also possible, unlikely but not unfeasible, for it to reverse entirely and crash back down.

Stop Loss rules are not easy to create, and even once they're created it's not always easy to adhere to them. Sometimes, hindsight will show that your Stop Loss actually caused you to exit what could have been a profitable trade. But providing your trades are based on solid decision-making, and your Stop Losses are appropriate to your strategy, they will save you an extraordinary amount of money and keep you in the trading game long enough to hone your skills.

@jonathanjohnson @doughelton I hope this helps!
Nathan Worden's avatar
This is gold Michael 👏
The examples are very approachable & clear, and the preamble and explanation of the rule provide the necessary context for people to fully understand the type of investing you’re doing and how you’re going about doing it. Great post!
Michael Panebianco's avatar
Thank you, Nathan. I appreciate it :)

I'm glad it's come across as intended and is clear. The Risk Management information I found early on when I started trading wasn't what I needed it to be - hopefully people in the same situation will find this useful.
Jonathan's avatar
There should be a section of Commonstock for learning materials on different kinds of investing and this post should be one of the first things people read when learning about technical analysis.
Michael Panebianco's avatar
Thanks Jonathan. I'm glad it's helped!

@commonstock Idea from Jonathan for you - Learning Area/Knowledgebase.
sam stribling's avatar
@jonathanjohnson I completely agree great 💡!
sam stribling's avatar
@tecantra I haven’t used stop losses before but find this very useful and interesting. I do have a question. I try and go for a long term buy and hold strategy. So I do a lot of DCA (dollar cost averaging) that truthfully I should put more formal rules around like your strategy outline above.

So, question is.. can I use stop losses in conjunction with my DCA strategy or does it conflict? Maybe I set a loss farther out than what you do or something. Essentially, if the price were to drop by 10% in one of my names I’d view it as a candidate to add to it vs. cut it. That said, I would love to have some sort of downside protection strategy like what you are doing with stop losses.

Looking to learn so anyone please chime in!
Michael Panebianco's avatar
@strib I believe Stop Losses can be incorporated into any strategy; the difficulty is developing the right Stop Losses for said strategy.

If you're happy to share some of your strategy and what helps you to determine the value and extent of your investments, I'd be very happy to help put some ideas to work. I've only ever explored Stop Losses to the extent that I require so talking about it with other people will help me learn more.

If you have some time next week we could jump on a Teams call and have a chat?
sam stribling's avatar
@tecantra would love to! I’ll just message you!
Nathan Worden's avatar
@tecantra when you and I were on the call with @gkotak , one of my takeaways from what you said was how if you zoom out the timeframe, candles are still just candles. So a stop loss can be incorporated into a longer term strategy because the same principals and patterns still apply.

If the timing works out, I’d love to be a fly on the wall of a @tecantra <> @strib convo.
Sidni Standard's avatar
Honestly, me too!!
Michael Panebianco's avatar
Hey @sidnistandard. We've scheduled in a Zoom call for Tue Oct 19, 2021 2pm – 3pm Pacific Time - Los Angeles. If that works for you we'll ask Nathan nicely to extend the invite to you :)
Sidni Standard's avatar
Sadly that won't work :(
Is it possible to record it so I can watch later?

Btw, this could be a new business idea for a YT channel! (a visual podcast that explores investment strategies)
Michael Panebianco's avatar
Haha, we mentioned in the pre-meeting chat that it might be worthwhile to record. I'm sure Nathan will (or Sam and I will remind him) and we'll make it available somehow.
Emmet Barta's avatar
I Set a stop loss one week and found it hurt me more when early morning dip set off my stop loss and then shot up on a daily gain leaving me with sold at a lower level so how could I avoid this
Michael Panebianco's avatar
@sfcbemmet It's an unfortunate and inevitable side-effect of Stop Losses - it's exactly what happened to me in the $APA example above.

But for every dollar they cost you, they will save you so much more in the long run.

Before you can determine what your Stop Losses will be, you need to have formal rules in place that govern when you enter and exit a trade. If you have some trading rules already in place then feel free to pop them here and we can take a look together (or DM if that's better). If you're unsure of what your trading rules are or should be then that needs to be in place before you can begin to see where your Stop Losses will be.
Hota Hota's avatar
@sfcbemmet that just happens. I have been riding the recent run up in NAIL. I have a trailing stop loss of 10% on it. I should have had it at 15% since it is a leveraged ETF. Unfortunately it hit my trailing stop this morning right after open then proceeded to close up another 5% today. Oh well, live and learn
Hota Hota's avatar
@strib I use the same stop loss as the OP 10% of entry price. I also use DCA but do not change the stop loss. If something falls back 5% I double my position but keep the same stop loss. On a high conviction play that is also more volatile, or a leveraged ETF, etc I will often use a 15% stop loss. On those I will double at 5% loss and then again add the original purchase at 10% down. I have also recently started adding to the position at 5% up and moving the stop loss up as well. Trying to catch momentum. Once again though, only on high conviction plays or leveraged ETFs.
Todd Campbell's avatar
Awesome post! I really appreciate how thoughtfully you put it together!
Michael Panebianco's avatar
Thanks Todd!
sam stribling's avatar
For sure @nathanworden would like your perspective as well!
sam stribling's avatar
Thank you! I’m going to start weaving them into my strategy