How to Calculate Stop Loss

Last Updated: 10 Dec 2024

When we talk of intraday trading, we think of stopping losses. But that raises several questions. How to calculate stop loss and how to determine to stop loss levels? If you are wondering how to calculate stop loss for intraday trading, you must surely read on. For the sake of simplicity, we will focus only on how to calculate stop loss for intraday trading and not discuss other asset classes. For example, we will not be dealing with how to calculate stop loss for options or futures or even for currencies and commodities.

Calculation Methods of Stop Loss

To understand how to calculate stop loss, you must be clear about two aspects. Firstly, what is the loss that you willing and able to take? Secondly, what are the best technical levels to set the stop-loss? It is only when you answer these two questions that you can answer how to calculate the stop loss. Let us look at 3 important approaches to calculate the stop losses.

Calculate Stop Loss Using the Percentage Method

The percentage method is a straightforward way of managing risk. Traders set a stop loss at a fixed percentage below the purchase price, which ensures that they do not lose more than a certain portion of their capital.

For example, if you buy a stock at ₹200 and set a 5% stop loss, your exit point would be ₹190. This method is very popular for intraday trading, especially when volatility is high, and a quick decision is required. Predefining the acceptable loss percentage keeps emotions in control and ensures disciplined trading in any kind of market fluctuation.

Calculate Stop Loss Using the Support Method

The support method involves placing a stop loss below a key support level, which is a price point where the stock has historically resisted further decline. If the stock falls below this level, it signals a potential trend reversal, prompting an exit.

For instance, if it is trading at ₹150 and the support level is at ₹140, then allowing a stop loss slightly below ₹140 would minimise loss but still give a stock enough room to get back. This is generally preferred by technical traders who analyse chart patterns and historical behaviour of prices to make such decisions.

Calculate Stop Loss Using the Moving Averages Method

In the moving averages method, the average price of a stock over a specified period is used to set the stop loss. Most traders use 20-day or 50-day moving averages as references. The stop loss is then placed slightly below this moving average to prevent huge declines.

For example, if a stock’s 20-day moving average is ₹500, the stop loss would be placed at ₹495. This strategy follows the market trend and is best for swing and positional traders who aim to capture medium to long-term price movements while managing risk effectively.

How to set stop loss?

This is one of the most important decisions for an intraday trader. Stop-loss serves as a kind of insurance for the trader and also tells how much the trader stands to lose on a particular trade if the stock moves against them. Even the best of traders in the world don’t get all their trades right and that is where stop losses fit in. The stop-loss order helps minimize loss.

The first question is whether stop loss should be a forethought or an afterthought? It must be aforethought. An intraday trader must assign the stop loss level beforehand itself. When the stock price reaches the stop loss level, the transaction is automatically terminated. The trader may lose a small sum of money but in the process can protect the capital from eroding too much. Just a word of caution, don’t keep moving your stop loss unless justified.

As we have discussed, the stop loss can be set based on a percentage basis, support/resistance basis, and moving average basis. The trick to use stop losses to protect risk. Stop-loss indicates the level of risk or loss you are ok with and that does not substantially damage your capital.

Risk reward is very important for trading intraday. No point in setting a 1% stop loss and 1% price target. The golden rule is to have a ratio of 2.5: 1 or 3:1 for effective intraday trading. Stop loss is normally a trade-off. If you set the stop loss level too far, you run the risk of losing a lot of money if the stock price goes against you. On the other hand, if you set stop loss level too close to buying price or selling price, these stop losses can trigger with the slightest spike in volatility and that is not good news.

Frequently Asked Questions

What is a trigger price?

Trigger price is the stop loss trigger at which the position is stopped out and the loss is booked. It is meant to protect the trader. This trigger price can be an absolute price, or a percentage price or it can also be a price based on technical levels or moving averages.

What if a stop loss fails?

There are two ways in which the stop loss can fail. In the case of illiquid stocks, there may be no buyers so that stop loss may not get triggered. Secondly, the stop loss can also fail if the trading is halted for some reason. These are routine risks and does not in any way dilute the importance of stop losses in trading.

What is the golden rule for stop loss?

The golden rule for stop loss is the limit of losses, which you place by setting a predefined price to exit a trade if it moves against you. This rule usually applies to risking only a small percentage of your capital, 1-2% per trade, to protect your investment portfolio from significant losses.

What is the best stop-loss rule?

The best stop-loss rule depends on the trader’s trading strategy and risk tolerance. A good rule of thumb is when the trade no longer aligns with your analysis. It’s time to set a stop-loss order. Most traders apply technical levels such as points of support or resistance in order to ensure that losses are within a manageable percentage of their capital.

What is an example of a stop-loss?

Suppose you bought a stock at ₹500, and it was perceived to move upwards. One sets a stop-loss at ₹450 so that in case the share falls to ₹450, one can sell his stock automatically and halt loss any further by ₹50 per stock.