The meaning of Stop-Loss for Option, Future and Stock Traders

Imagine you have $2,000 to invest, but you're only willing to risk $400 on any single trade. Here’s how two different approaches might play out:

1. No Stop Loss

   • With each "ABC" contract priced at $2 ($200 per lot), you can afford 2 contracts, totaling $400.

   • If the trade goes south, your investment plummets to zero, and you lose $400.

   • 
     

2. 20% Stop Loss

   • By setting a stop loss at 20%, you can buy 10 contracts for the full $4,000.

   • If the trade drops 20%, your position declines to $1600, resulting in the same $400 loss.

Now let’s assume the trade works in your favor, and "ABC" doubles to $4 per contract ($400 per lot):

• No Stop Loss (2 contracts): Your position grows to $800, netting a $400 profit. That’s a 1:1 risk-reward ratio.

  
  

• With a Stop Loss (10 contracts): Your position skyrockets to $4,000, earning $2,000 in profit—a 5:1 risk-reward ratio.

  
  

The risk—$400—is identical in both cases. The percentage gain is also the same at 100%. But by leveraging a 20% stop loss, you can take a much larger position, dramatically enhancing your potential reward if the trade succeeds.

Stop losses aren’t just about protecting the downside. They also amplify the upside by allowing you to maximize your initial position while keeping risk tightly controlled.

Disadvantages of Stop-Loss Orders in Daily/Swing Trading

One significant drawback of using a stop-loss order is the risk of short-term price volatility triggering the stop price, leading to a premature sale. The secret lies in selecting a stop-loss percentage that accommodates normal daily fluctuations without exposing you to excessive losses.

For instance, applying a 5% stop-loss to a stock that routinely swings 10% or more within a week isn’t the wisest move—it’s a recipe for losing money on unnecessary commissions.

There’s no one-size-fits-all rule for determining the ideal stop-loss level; it’s entirely tailored to your investment approach. A fast-paced trader might lean toward a 5% threshold, while a patient, long-term investor could opt for 15% or even higher.

It’s also worth noting that when your stop price is reached, your stop order automatically converts into a market order. This means your stock could sell at a price far from your stop, particularly in volatile markets where prices can shift in an instant.

Lastly, be aware of restrictions. Many brokers won’t permit stop orders for certain securities, like OTC Bulletin Board stocks or penny stocks, further limiting your options.

How do you find the perfect price level for a stop-loss order?

The answer lies in balancing factors like your risk appetite, the security’s volatility, and your long-term investment objectives. Savvy investors frequently rely on technical analysis, focusing on support and resistance levels to pinpoint optimal stop-loss prices.

In some markets or securities, retracements—those temporary pullbacks before a recovery—are a common occurrence. Navigating such patterns calls for a dynamic approach: a well-timed stop-loss coupled with a thoughtful re-entry strategy can make all the difference in capitalizing on these movements.

This secret is nothing but the knowledge of trading using Market Profile, Volume Profile, Orderflow Footprint, SMC, and Basic TA. 360 experts creatively combined all the knowledges of different styles to understand who we are trading with at any given time.

Visit us at 360tradingcourse.com to learn all the secrets that Wall-Street hiding from you!

Sources: 360 and IBD