Stop losses are an important part of a profitable trading strategy.
It limits your risk if you make a mistake, 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 in calculating a stop loss is to measure your stop loss in pips or dollars, or whatever your chart is quoted.
To calculate your exact stop loss, use this formula:
ABS(Entry – Stop Loss) = Risk
It doesn’t matter if the hazard number comes out positive or negative. Take the absolute value (ABS) of the entry price minus the stop loss price.
Let’s look at some examples from different markets. In each example, the line represents a stop loss.
Example of Stock Trading
If you sell US stocks, the risk is 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 will make money if the price goes down.
So the risk is: 67.50 – 59.60 = 7.90.
Example of Forex Trading
In Forex, risk is calculated in pips or pipettes, depending on how the broker quotes prices.
The price is quoted in the second currency of the pair, or the quote currency.
For example, in the EURCHF chart below, the chart is quoted in Swiss Francs because the 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 to 154.1 pips of risk.
Example of Crypto Trading
Crypto can be a bit tricky because trading pairs are quoted in different formats, depending on which crypto the quote currency is in the pair.
This is the Monero/US Dollar pair, quoted in US Dollars.
The risk of this long trade is: 134.23 – 115.332 = 18.898.
Now that you have a good idea of how it works, let’s look at how to calculate your percentage risk on each trade based on your calculated stop loss.
How to Calculate Percentage Stop Loss
Once you’ve calculated the stop loss quote value, now it’s time to determine your position size based on your percentage risk.
This is very important because you want to keep your risk on each trade consistent.
If you don’t keep your risk constant, you may lose too much in one trade and not enough in the next trade to make up for the loss.
For example, let’s say you risked 3% on your first trade and it was a losing trade. Then you risk 1% on your next trade and make a profit of 1%.
You are still down 2%, even though you have one win and one loss.
If you risk 1% per trade and aim for 1% profit per trade, you may be at breakeven.
If you keep your risk per trade constant, that removes a 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 will assume that you have a $10,000 account and risk 1% per trade.
A percentage of $10,000 is:
10,000 x 0.01 = $100
So all the trades below only carry $100 of risk.
Today I will show you how to determine the value of shares, units or cryptocurrency to buy or sell.
I will use the same amount at risk in dollars and pips from the examples in the previous section.
Example of Stock Trading
In the example above, there is 7.90 risk per share in the stock trade.
So to get the number of shares you need to sell, 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.
Example of Forex Trading
It can be a little tricky to calculate your total Forex trade size because there are different lot sizes and the risk per pip varies between currency pairs.
If you don’t know about Forex lot sizes, you can learn about it 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 say you want to sell micro lots. These lots have a risk of around $0.10 per pip, depending on the currency pair.
But I will 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 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 have only 1% risk in your account.
Example of Crypto Trading
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 can buy 5.2915652 Monero coins.
If the coin/token you are selling is quoted in another cryptocurrency, then:
- Calculate the risk of the quote currency
- Convert the quote currency to US Dollars (or whatever your trading account denomination is)
- 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 is a Trailing Stop Order and Should You Use One?
There are many different ways that a trailing stop loss can be implemented.
They help you lock in profits as your trade moves towards profitability.
You can learn about the most used types of stoppages here.
In that article, I also show you which ones to avoid.
Where To Place Your Stop Loss
The next question is obvious, where should you place your stop loss.
That will depend on your trading system.
If you want to see different trading strategies, then check out the strategies I have written and tested.
But the basic idea is that you want to place your stop loss somewhere that isn’t susceptible to normal market fluctuations.
At the same time, you want to place the stop loss somewhere that will show you that you were wrong about the trade.
Brokers don’t look for your stop losses.
Many new traders believe this because they are constantly getting stuck.
In fact, most new traders place their stop loss at the close of their entry and simply stop in the normal order.
Here are 2 examples of stop loss levels that 2 traders can choose.
A new trader usually chooses a stop that is too close to the price action…
While a more experienced trader will usually choose a stop loss level that is further away, as shown above.
So the bottom line is that you want to pick a stop loss price that proves you wrong, but also isn’t so close to your entry that it gets stopped out easily.
Final Thoughts
Stop loss is the best way for traders to manage risk.
…especially new entrepreneurs.
If you have a trading plan that includes a stop loss, you know how much you can lose if you are wrong about the trade.
If you don’t have a business 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.