A stop loss a vital component of a profitable trading strategy.
It limits your risk if you're wrong, and it preserves your capital so you can take advantage of the next opportunity.
This complete tutorial will show you how to calculate your risk and position size, based on your maximum risk.
Calculate Your Stop Loss
The first step to calculating a stop loss is to measure your stop loss in pips or dollars, or whatever your chart is quoted in.
To calculate your exact stop loss, use this formula:
ABS(Entry – Stop Loss) = Risk
It doesn't matter if the risk number comes out positive or negative. Take the absolute value (ABS) of the entry price minus the stop loss price.
Let's take a look at a few examples from different markets. In each example, the line represents the stop loss.
Stock Trading Example
When you trade US stocks, the risk will be calculated in dollars.
In this example, the stop loss is at 67.50 and the entry price is 59.60.
This is a short trade, so the trade makes money when the price goes down.
So the risk is: 67.50 – 59.60 = 7.90.
Forex Trading Example
In Forex, risk is calculated in pips or pipettes, depending on how the broker quotes prices.
The price is quoted in the second currency in the pair, or the quote currency.
For example, in the EURCHF chart below, the chart is quoted in Swiss Francs since CHF is the second currency.
The stop loss is at 0.97068 and the entry price is at 0.98609.
So the risk is: 0.98609 – 0.97068 = 0.01541.
This translates into 154.1 pips of risk.
Crypto Trading Example
Crypto can be a little tricky because trading pairs are quoted in different formats, depending on which crypto is the quote currency in the pair.
This is the Monero/US Dollar pair, which is quoted in US Dollars.
The risk on this long trade is: 134.23 – 115.332 = 18.898.
Now that you have a good idea of how this works, let's take a look at how to calculate your percentage risk per trade based on your calculated stop loss.
How to Calculate Stop Loss Percentage
Once you've calculated the stop loss in quote value, now it's time to figure out your position size based on your percent risk.
This is very important because you want to keep your risk per trade constant.
If you don't keep your risk constant, you might lose too much on one trade and not make enough on the next trade to make up for the loss.
For example, let's say that you risked 3% on your first trade and it was a losing trade. Then you risked 1% on your next trade and it made a profit of 1%.
You would still be down 2%, even though you had one win and one loss.
If you risked 1% per trade and targeted 1% profit on each trade, you would have been at breakeven.
When you keep your risk per trade constant, that eliminates one variable from your trading and allows you to focus on more important things like your win rate and your return per trade.
In these examples, I'm going to assume that you have a $10,000 account and you're risking 1% per trade.
One percent of $10,000 is:
10,000 x 0.01 = $100
So all of the trades below will only take $100 of risk.
Now I'll show you how to figure out the amount of shares, units or cryptocurrency to buy or sell.
I'm going to use the same risk amounts in dollars and pips from the examples in the previous section.
Stock Trading Example
In the example above, there was 7.90 of risk per share on that stock trade.
So to get the number of shares that you should trade, simply divide the total risk you want to take ($100) by the risk per share ($7.90).
$100 / $7.90 = 12.6
Therefore, you should sell short 12 shares of stock in this example.
Forex Trading Example
It can be a little tricky to calculate your total trade size in Forex because there are different lot sizes and the risk per pip varies between currency pairs.
If you don't know anything about Forex lot sizes, you can learn about them here.
To make things easier, you can use a position size calculator like this one.
But I'll show you the calculation so you know now to do it yourself.
In the example above, the long trade has 154.1 pips of risk.
Let's just say that you want to trade micro lots. These lots have a risk of about $0.10 per pip, depending on the currency pair.
But I'll use $0.10 just for demonstration purposes.
First, multiply the pips of risk times the cost per pip.
154.1 x 0.10 = 15.4
That gives you $15.40 of risk per micro lot.
Then divide the total risk by the risk per micro lot.
$100 / $15.40 = 6.49
So in this example, you can trade 6 micro lots to only have 1% risk in your account.
Crypto Trading Example
Since this crypto chart is quoted in US dollars, the calculation is similar to the stock trading example.
$100 (total risk) / $18.898 (risk per coin) = 5.2915652
Cryptocurrency can be divided beyond 2 decimal points, so in this example, you would be able to buy 5.2915652 Monero coins.
If the coin/token you're trading is quoted in another cryptocurrency, then:
- Calculate the risk in the quote currency
- Convert the quote currency to US Dollars (or whatever your trading account is denominated in)
- Divide your total risk ($100 in this example) by the risk per coin/token in US Dollars to get the number of coins/tokens to trade
That's it!
Easy.
Frequently Asked Questions
What's a Trailing Stop Order and Should You Use One?
There are several different ways that a trailing stop loss can be implemented.
They can help you lock in profits as your trade moves into profit.
You can learn about the most used types of trailing stops here.
In that article, I also show you which one to avoid.
Where Should You Set Your Stop Loss
The next question is obviously, where should you place your stop loss.
That will depend on your trading system.
If you want to see different trading strategies, then take a look at the strategies I've written about and tested.
But the basic idea is that you want to put your stop loss in a place that's not easy for the normal fluctuations of the market to get to.
At the same time, you want to put the stop loss in a place that will show you that you're wrong about the trade.
Brokers don't hunt your stop losses.
Many new traders believe this because they get stopped out so often.
In reality, most new traders put their stop loss to close to their entry and simply get stopped out by normal volatility.
Here are 2 examples of stop loss levels that 2 traders might choose.
A newer trader will usually choose a stop that's too close to price action…
While a more experienced trader will usually select a stop loss level that's further away, as shown above.
So the bottom line is that you want to select a stop loss price that proves you're wrong, but also isn't so close to your entry that it can get stopped out easily.
Final Thoughts
A stop loss is the best way for traders to manage risk.
…especially new traders.
When you have a trading plan that includes a stop loss, you know exactly how much you'll lose if you're wrong about the trade.
If you don't have a trading plan, then learn how to create one here.
There are some trading methods that do not use stop losses, but they should only be used once you have a little experience.
