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Tips on How to Figure a Stock Stop Loss

written by: Tim Plaehn•edited by: John Garger•updated: 2/24/2011

A valuable technique to protect account values in stock market investing or trading is the use of stop loss orders. Read on to learn how to figure stop loss for stocks.

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    Stop Loss in Stock Investing

    Before discussing how to figure stop loss for stocks, this discussion begins with what the strategy is and then how to set it up. A stop loss is a pending stock market order that will sell out a stock position if the stock price declines to a certain level. The purpose of a stop loss is to prevent mounting losses due to keeping a stock in a portfolio when the price is declining. The stop loss can be used to protect gains if you have a stock with a big profit in the position or minimize the losses if you made a bad choice with a recent stock purchase.

    A stop loss is set up in the order screen of your online stock brokerage account. You enter the stock symbol, the number of shares you own, and then select stop loss as the order type. You will then have a box to enter your stop loss price for the stock. Make sure the good til cancelled - GTC - box is selected. Now if the stock price drops to or below your selected stop loss share price, a market order will be entered to sell your shares.

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    Calculating a Stop Loss

    Generic Stock Price Chart 

    The traditional rule of thumb for setting a stop loss is 10% below the current stock price. Before blindly setting all of you stop losses at 10%, analyze the share price history of your stocks. If a stock is significant volatile, a 10% stop loss may lead to a stock position being stopped out - stock market jargon for having a stop loss order activated - due to normal price fluctuations. Short term traders may use a stop of 5% while long term investors who just want to avoid losses from a major market downturn may set a stop loss at 15%.

    Technical, chart watching trader types may want to use a technical indicator from a stock's chart history to set the stop loss. Techniques include setting the stop watch just below a supporting trend line. The rational is that if the stock price breaks the trend, the price will continue lower.

    Another technical indicator that can be used as a stop loss is a moving average. Select the moving average that seems to provide the best historical price support and set the stop loss just below the current level of the moving average line.

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    Managing Your Stop Loss

    It is important to manage your stop loss price as a trailing stop loss. As your stock price moves higher, the stop loss price will also go up. If you are using a percentage stop loss, the price difference between the stop loss price and the stock loss price will widen as the stock rises. For example, using a 10% stop loss for a stock trading at $50, the stop loss would be set at $45. If the stock moves up to $70, the stop loss would be set at $63. Using technical indicators moves the trailing stop up as the indicators react to a higher stock price.

    If you use and depend on a stop loss price, never lower the stop loss. The purpose of how to figure a stop loss for stocks is to set up a system that prevents large losses or loss of profits in you stock investments and portfolio.

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    References

    Investopedia: The Stop Loss Order, Make Sure You Use It http://www.investopedia.com/articles/stocks/09/use-stop-loss.asp

    Photo Credit: Flickr Creative Commons Attribution / ponzi unit