The most elementary way to set your stop loss is based on a percentage of your account — the percentage-based stop loss. This method uses a fixed percentage of the trader’s account to set the stop. For example, a trader might specify in their trading strategy that they are willing to risk 3% of the account on a trade.
Determine What Percentage of Your Account You’re Comfortable Losing
Determining how much of your account you’re comfortable losing is an important part of risk management. Losing a certain portion of your account with each trade is a difficult concept to face, but it’s an essential element for preserving long-term bankroll stability.
The percentage that a trader specifies is entirely up to them and can vary from trader to trader. Some of the more aggressive traders decide to risk 10% of their account, for example, while more conservative traders have 1-2% risk per trade.
The Danger of Using a Percentage-Based Stop-Loss
When setting a stop loss, it is important to always consider the market environment and the system rules rather than what you are willing or able to risk.
What do we mean? Think about this scenario…
In a previous article, we talked about position sizing, which can impact a percentage-based stop-loss if position sizing is too large.
Imagine you have a mini account with a $500 account balance. The minimum size you can trade is 10,000 units. You want to take out a short trade on EURUSD because you see a resistance zone holding around the 1.0657 level.
Per your risk management rules, you decide that you are only going to risk 2% of your account maximum. At 10,000 units of EURUSD, each pip is worth $1, and 2% of your account is $10. According to your percentage-based stop loss, the largest stop you can put on is 10 pips, which is what you do on this trade below, setting your stop at 1.0667.
Wait… EURUSD can move 50 to 100 pips in a day. You are running the risk of getting stopped on the smallest move — which is exactly what happens. Your trade hits the stop and you miss the entire downward move that you correctly predicted.
That is the danger of basing your stop loss solely on how much you want to lose instead of the prevailing market conditions of EURUSD.
Take a look at what happened to your trade. As you can see, the danger of using a percentage-based stop loss is that you are setting your stop at an arbitrary price level, giving no mind to market conditions. If you want to stay within your 2% stop-loss parameters, you are going to have to adjust your position sizing.
Disclaimer: All information provided here is intended solely for study purposes related to trading financial markets and does not serve in any way as a specific investment recommendation, business recommendation, investment opportunity, analysis, or similar general recommendation regarding the trading of investment instruments. The content, in its entirety or parts, is the sole opinion of SurgeTrader and is intended for educational purposes only. The historical results and/or track record does not imply that the same progress is replicable and does not guarantee profits or future profitable trading records or any promises whatsoever. Trading in financial markets is a high-risk activity and it is advised not to risk more than one can afford to lose.