Determining stop-loss order placement is all about targeting an allowable risk threshold. This price should be strategically derived with the intention of limiting loss. For example, if a stock is purchased at $30 and the stop-loss is placed at $24, the stop-loss is limiting downside capture to 20% of the original position. If the 20% threshold is where you are comfortable, place a trailing stop-loss.

There are plenty of theories on stop-loss placement. Technical traders are always looking for ways to time the market, and different stop or limit orders have different uses depending on the type of timing techniques being implemented. Some theories use universal placements (such as 6% trailing stops on all securities) and some theories use security or pattern-specific placements (including average true range percentage stops).

Stop-Loss Placement Methods

Common methods include the percentage method described above, the support method (which involves hard stops at a set price) and the moving average method (in which stop-losses are placed just below a longer-term moving average price).

Swing traders often employ a multiple-day high/low method, in which stops are placed at the low price of a pre-determined day's trading. For example, lows might consistently be re-placed at the two-day low. More patient traders might use indicator stops based on larger trend analysis. Indicator stops are often coupled with other technical indicators, such as the relative strength index (RSI).

The Bottom Line

Traders should evaluate their own risk tolerances to determine stop-loss placements. Specific markets or securities should be studied to understand whether retracements are common. Securities that show retracements require a more active stop-loss and re-entry strategy. Stop-losses are a form of profit capturing and risk management, but they do not guarantee profitability.