InvestorQ : Are there some basic rules I must follow when setting a stop loss?
Abhisha Yadav made post

Are there some basic rules I must follow when setting a stop loss?

Abhisha Yadav answered.
3 years ago

Firstly, remember that a stop loss should be used as a risk control measure. Don’t use a stop loss level to blindly double your bets. If you stopped out your long trade of rs.150 at rs.145 and if stock goes down to 135 don’t jump in to double up your trade. It is ok to be wrong once, but you cannot be wrong twice. Averaging at the stop loss level is not a great idea.

A long term holding can also have a stop loss. That is usually referred to as a trailing stop loss which constantly gets reset as the stock or index continues to move in your favour. The idea of a trailing stop loss is to protect your gains in the event of any negative market events.

Don’t ever look at the stop loss as a regret level. Let me explain this point a little more elaborately. It often happens that your long trade hits a stop loss and then bounces up. Don’t treat this as an opportunity loss. Remember, that a stop loss is about protecting your capital, not about whether your trade was right or wrong. Once stop loss is triggered, don’t keep looking back and regretting the opportunity loss of profits not made.

You can also set indirect stop losses by buying put options on your long positions. But remember option buying has a cost in the form of premium paid. You can also use reverse futures as a stop loss but they run the risk of mark-to-market margins. And as Buffet said, “At their worst, some derivatives can be weapons of mass destruction”. Watch out and be careful of how much risk you are running on an overall basis!

Lastly, when you place a stop loss keep an eye on the volume and order book as it matters a good bit. Place the stop loss at a level which shows sufficient supply and demand, depending on your trade direction. Stop losses, essentially should be market orders so you don’t want to see illiquid drops. Also select the less traded strikes so that you are high on time priority.