What is a Stop Loss in Day Trading, and How To Use It

What is a Stop Loss in Day Trading, and How To Use It

When you place trades, risk management is the key to minimizing your losses. The best way to set up your risk management strategy is by placing a stop loss.


A stop loss is a type of order that gets you out of a trade at a pre-specified level. It is a way to control trading risk by telling the broker, “If the asset reaches X price, get me out.”

Stop losses are imperative for day traders because prices move quickly – having a stop loss assures you get out of the trade if a pre-specified level is reached. You don’t have to rely on your memory or reflexes, which may get you out of the trade later than an automated order.

What is a Stop Loss in Day Trading, and How To Use It

Learning how to use stop loss orders is an important skill to have, because controlling risk is an important skill for successful trading. Today, we will cover what a stop loss is, the different types of stop losses, how to place a stop loss, and where to put a stop loss when entering a trade.

What is a Stop Loss in Day Trading

What is a Stop Loss in Day Trading

A stop loss order is an order that closes a trade if the price starts moving against the direction of the position. The order type is actually a “stop order”, but it is referred to as a stop loss in this context.

A sell stop order will sell below the current price. If you purchase a stock or other asset, then your stop loss is a sell stop, because it will sell at a lower price than where you entered.

A buy stop order will buy above the current price. If you short sell a stock or forex pair, then your stop loss will be a buy stop because it buys (to close your position) above where you entered.

The stop loss strategy controls the risk on the trade in the event the price doesn’t go in the direction you expect. For example, let’s say you buy a stock at $50.25 expecting it will rise. You set a stop loss (sell stop) at $49.99 just in case it doesn’t. This way, you limit your risk to $0.26 per share.

If you shorted the EUR/USD at 1.1525, and placed a stop loss (buy stop) at 1.1535, the order will get you once the price has moved 10 pips against you. With many brokers, placing an entry order will also give you the option to place a stop loss. In this case, simply enter the stop loss price you want to use. You don’t need to select the order type (sell stop or buy stop).

Further reading

Different Types of Stop Losses

Different Types of Stop Losses

There are several types of stop losses, but the main ones are market, limit, psychological, and physical. In nearly all cases you will be using a market-physical stop loss, but it’s worth understanding the other types as well.

The most common type of stop loss order has two key features:

  • Market – meaning the stop loss is a market order. When the stop loss is reached the order is sent out and will use the current market rate to exit the position.
  • Physical – meaning the order has been physically placed and the stop loss order is pending with the broker, ready to be deployed if the stop loss price is reached.

If you are placing the order, it is physical, and by default, stop loss orders are market orders. While these are the most common types of stop losses used among professional day traders, there are a couple of other choices.

  • Stop Limit – a stop limit will only get you out of a trade within a pre-specified price area.
  • Mental – a mental stop loss means you don’t actually place a stop loss order. Rather, you mentally decide where you will exit, and then if the price reaches that level you manually exit the trade.

If you opt to use a mental stop loss, that means if you have bought something, you just have to sell it to close the position. If you are short, you have to buy the same amount to close the position. A stop limit adds a “limit” to the stop order. For example, if you buy a stock at 25.60, you could place a stop limit order at 25.50 (stop) and 25.40 (limit).

This means if the stock price reaches 25.50, the order is deployed and it would try to sell your position at whatever the current market rate is. However, it would only sell your position if it can get you out at 25.40 or higher. In this scenario, it would only get out between 25.50 and 25.40, and no lower.

If the price were to “gap” from 25.50, and the next person willing to buy is at 25.39, you would still be in this position until someone is willing to buy at 25.40 or higher. At that point, your order to sell would be executed. If the price keeps dropping, without the order executing, you are still in the trade and the loss is getting bigger.

There is almost no need to use a stop limit order as a stop loss when day trading; simply get out of the trade using the default market order and move onto the next trade.

 move onto the next trade

Further reading

How to Place a Day Trading Stop Loss

How to Place a Day Trading Stop Loss

In order to manage risk, the stop loss needs to be physically placed. As discussed above, just thinking about where you should get out isn’t good enough. One lapse in attention could mean a significant loss.

Let’s discuss how to place a stop loss, so you always know your risk is controlled.

Most brokers allow you to place a stop loss when placing an entry order. If you are given this option, when placing a trade entry price, input the price of the stop loss. When you send the entry order, the stop loss is attached to it and will get you out if the price reaches the stop loss level. The stop loss order only comes into effect once you are in a trade.

If the broker doesn’t offer you a stop loss option when making a trade, you can input it manually using the order types discussed above. If you are buying, enter the trade and then input a sell stop order at the price you want to get out of the trade. If you are shorting, enter the trade and then input a buy stop order to get out of the trade if the price goes against you.

If you are in a trade and don’t have time to place a stop loss, you can always close a trade manually by selecting the “Close” option. Most brokers offer this. You might be able to right-click on the trade to access this option, or there may be an “x” you click beside the trade to close it. This is a manual exit option, so it is like a mental stop loss.

Further reading

Where to Place a Stop Loss Order

Where to Place a Stop Loss Order

When you enter a trade, you need to decide at what price level to place the stop loss. The general idea is to place the stop loss at a price that would indicate you were wrong about the trade – at least for now.

Many day traders use recent swing highs and lows for stop loss locations, or reference recent candle highs and lows. Here is a chart example:

candle highs and lows

The price is rallying, and then forms a consolidation. A consolidation is when the price action moves sideways for at least a couple of price bars. The price then moves above the most recent candle high and/or breaks above the high of the consolidation. This is a trend trading strategy signal to enter a buy.

A stop loss is placed below a recent candle low, or below the consolidation low. The trade is potentially profitable if the price rallies after breaking higher (our entry). The stop loss is there in case the price triggers us into a trade but then drops back down. This is not what we wanted from the trade, so the stop loss does its job and gets us out.

In this particular case, the stop loss wasn’t needed because the price rallied after the entry and we could get out for a profit. That is a good reminder that controlling risk with a stop loss is only part of the trading equation. You also need a method for taking profits when trades do work out.

I recommend using a One-Cancels-Other (OCO) order on every trade. An OCO order allows you to place your entry, stop loss, and profit target (for taking profit) orders all at the same time.

Further reading


Can you change your stop loss order price?

Yes – as long as the stop loss order hasn’t been executed yet, it can be altered. Avoid making the stop loss bigger to avoid taking a loss.

Expanding the stop loss means you are taking on more risk than you originally planned, which is not a good habit to get into. If the price has moved favorably after your entry, you can also move the stop loss to reduce your risk or lock in a profit. This is called a trailing stop loss.

What is a trailing stop loss?

A trailing stop loss is a stop loss order that moves to lock in profit or reduce risk as the trade moves favorably. A trailing stop loss can be automated, such as each time the price moves favorably by $0.10 or a $1 for example, the stop loss is moved by $0.10 to $1. Alternatively, you could simply manually move the stop loss or reduce risk or lock in profit. This is also a trailing stop loss.

Does a stop loss guarantee I won’t lose money?

No. A stop loss just means an order to exit the position is sent out when an asset reaches a certain price. That may result in a loss on the trade. There is also no guarantee your order will be executed at the exact stop loss price you specify. The order is just sent out at that price.

Can I always get out at the stop loss price I specify?

No. A stop loss order is sent out when an asset hits a certain price. The stop loss order will seek out the nearest available price to close the position. The nearest available is not always the specified stop loss price. You may actually get out at a worse price, a better price, or the same price.

What are the pros and cons of stop losses?

Placing a stop loss helps control risk on a trade. That is a major advantage. Some active traders don’t like stop losses because the price can hit the stop loss, causing you to exit your trade at a loss, and then price moves back in the direction you were expecting. While this can be frustrating, controlling losses on all trades is more important than being frustrated on the occasional trade.

Should I use a stop loss on every trade?

Most experienced day traders and swing traders use stop losses. These trades are short-term, so you are either right or you get out. Investors may opt not to use stop losses because they are holding a stock, ETF, or other asset for the long-term and thus they are not concerned with short-term price fluctuations. Whether you use a stop loss or not may be based on your trading style.

Final Thoughts

Understanding stop losses is important for day trading because these orders help mitigate risk. They also make trading less stressful, because once the stop loss order is placed, you don’t need to worry about missing your closing price. If the price reaches the stop loss, the trade will be closed.

All short-term trades should have a stop loss attached to them. If buying, consider placing a stop loss below a recent swing low or below a recent candle low.

If shorting, consider placing a stop loss above a recent swing high or above a recent candle high. What to learn more about day trading? Find out about the Pattern Day Trading Rule, and how to avoid it.

Further reading