How to use Stop Losses Lesson

In this lesson, you’ll learn how to implement effective stop loss strategies and take profit targets as part of your trade planning discipline. Understanding how to use stop losses is essential for managing risk and avoiding emotional decision-making in your trading.

A stop loss is an automated order placed with a broker to buy or sell once a stock reaches a certain price, designed to limit your loss on a securities position. While stop losses are less relevant for passive investing with buy-and-hold strategies, they are critical for active trading where you must establish your level of risk and potential return for every trade. Stop losses reflect your risk tolerance and trading psychology, acknowledging that not all trades will go in your favor.

The lesson covers four types of stop losses: fixed stop loss (set at a specific price point, like $95 on a $100 stock), trailing stop losses (adjusted as your position moves into profit to lock in gains), percentage-based stop loss (set at a percentage below purchase price, such as 10%), and indicator-based stops (using technical tools like support and resistance, Fibonacci levels, or moving averages).

You’ll see practical examples using a Microsoft stock trade entered at $387.24 with an initial stop at $385.89, then adjusted to break even at $387.24, and finally moved to $390.73 to secure a $3.49 profit per share. The lesson demonstrates how to use the 200-day moving average on Apple stock to place and adjust stops, how to set stops below support levels to exit when market structure breaks, and how to use Fibonacci retracement levels like 38.2%, 50%, and 61.8% to guide stop placement based on your risk tolerance.

Common mistakes to avoid include setting stops too tight (leading to premature exits from normal market fluctuations), not adjusting stop losses as positions move in your favor, and ignoring stop losses altogether. The key to trading success is thinking about how to limit risk for every trade, not just focusing on profits.

Video Chapters

00:00 – Introduction to trade planning and stop losses
01:20 – Types of stop losses: fixed and trailing
02:42 – Percentage-based and indicator-based stops
04:04 – Common mistakes with stop loss placement
04:27 – Using moving averages for stop losses
05:17 – Support and resistance levels for stops
05:41 – Fibonacci retracements as stop loss guides

Key Takeaways

A stop loss is an automated order that limits losses and helps avoid emotional decision-making in trading
Trailing stop losses allow you to adjust stops to break even and lock in profits as positions move in your favor
Use indicators like moving averages, support and resistance, and Fibonacci levels to guide stop loss placement
The key to trading success is managing risk for every trade, not just focusing on potential profits

Video Transcription

[00:00:00.05] - Speaker 1
In this lesson, we discuss trade planning and how to leverage stop losses and take profit targets. This is a very important concept if you want to be successful. A stop loss is an order placed with a broker to buy or sell once the stock reaches a certain price. It's designed to limit an investor's loss on a securities position. The beauty of a stop loss is that it's automated.

[00:00:24.12] - Speaker 1
It cuts your losses, helping you avoid emotional decision making or needing to constantly monitor your positions. While in passive investing strategies, stop losses are less relevant as your goal is the buy and hold and your time horizon is medium to long term. In active trading, however, stop losses and profit targets are very important. In every trade we execute, we establish the level of risk and potential return. For every trade, we need to have a plan and define our stop loss and take profit target.

[00:00:58.03] - Speaker 1
Stop losses are more than just a safety net. They're a reflection of your risk tolerance and trading psychology. Setting a stop loss means you're acknowledging that not all trades will go in your favor and that you're prepared to minimize losses without letting emotions cloud your judgment. Now let's look at the different types of stop losses. First, we have fix stop loss.

[00:01:20.12] - Speaker 1
In this case, we are setting the stop at a specific price point. For example, if a stock is trading at $100, we could set a stop at $95 and are willing to risk $5 per share on this trade. We then have trailing stop losses. This type is very useful when the trade is going in your favor. If your position is in profit, we typically adjust our stops to make sure we are minimizing the risk while still locking in profits.

[00:01:48.20] - Speaker 1
Lets do an example. On Microsoft stock, we entered a long order at $387.24 and set up our stop at $385.89. The price of the stock moves up and we are in profit. We could use trailing stops to adjust our initial stop order. The first step is to bring the stop to break even.

[00:02:12.27] - Speaker 1
In this case, our stop order will move from $385 to to $387.24. This allows us to limit our risk. We are not losing any money in case the price suddenly drops. If the price of the stock continues to rise, we could decide to modify our stop and change that order. The price is still above, but we are locking in a certain amount of profits by adjusting our stop loss.

[00:02:42.13] - Speaker 1
In this case, we set our trailing stop at $390 and $0.73, securing a $3.49 profit per share. We want to let the price continue its trend but secure profits in the meantime. If the price then falls, we are covered and have a successful trade. Remember, the key to success in trading is not to think about profits, but to think about how to limit our risk for every trade. Another type is the percentage based stop loss.

[00:03:13.04] - Speaker 1
Here we set at a certain percentage below the purchase price. For example, if our percentage is 10% and we trade a stock at $100, we would set our stop loss at $90. The last type is an indicator based stop. We could use indicators to help place our stops. For example, we could use support and resistance levels, Fibonacci moving averages and more.

[00:03:38.22] - Speaker 1
Before looking at practical examples, let's discuss some common mistakes traders make when defining their stops. Setting stop losses too tight. This can lead to getting stopped out prematurely in normal market fluctuations. Not adjusting stop losses. Failing to adjust stop losses in response to market changes or as a position moves in your favor can lead to unnecessary losses or missed profits.

[00:04:04.26] - Speaker 1
Ignoring stop losses, the discipline to respect your stop loss levels is crucial. Ignoring them can lead to significant losses. Now let's look at some examples of how to use indicators as support for our stop loss strategy. We will look at moving averages, support and resistance and Fibonacci levels. Let's start with moving averages.

[00:04:27.28] - Speaker 1
When trading with moving averages, you your stop loss can be set based on these dynamic levels. Moving averages help us follow the trend and can be indicators of potential reversals. We can use the 20, 50 or 200 period moving averages. In this example, we are Long Apple stock. We are using the 200 day moving average and can use the indicator to place our initial stop loss order.

[00:04:53.17] - Speaker 1
As the price moves up. We can adjust our stop by using the change of the moving average value. This allows us to ride the trend and protect ourselves from a potential reversal while still locking in profits. Support and resistance levels are important for identifying stop loss placements. A stop loss below a support level or above a resistance level ensures you exit the trade.

[00:05:17.13] - Speaker 1
When the market breaks these key levels indicating that the initial trade plan is no longer valid. In this case, we see how we can set up a stop loss below support. Our idea is that the price will bounce back to the upside. If that does not happen and the market structure gets broken, we want to exit the trade and limit our losses. The last example is using Fibonacci retracements.

[00:05:41.17] - Speaker 1
These levels can also guide stop loss placements. After entering a trade based on a Fibonacci level, you can set your stop loss beyond the next Fibonacci level. This approach is based on the premise that if a certain retracement level is breached, the the market may move to the next level. Suppose you enter a long position at a 38.2% Fibonacci retracement level. You could set your stop loss below the 50% or 61.8% retracement levels, depending on your risk tolerance and market analysis.

[00:06:16.10] - Speaker 1
You are betting on the continuation of the trend to the upside. The market bounced, but then retraced back to the 50% and 61.8%. In this case, the market structure was broken and by using Fibonacci levels as stop losses, we could have limited our risk. Effective stop loss placement is an important aspect of trading. It's not just about limiting losses, it's about protecting profits and managing risk.