A stop loss is a predetermined price level at which a trader exits a losing position to limit their loss. It is an order placed with a broker to automatically sell (or buy, for short positions) a security when it reaches a specific price, preventing further losses beyond a defined threshold.
A stop loss order is placed at a price below the entry price for long positions or above the entry price for short positions. When the market reaches that price, the order is triggered and the position is closed at the best available price. Stop losses can be fixed (set at a specific price), trailing (adjusting as the price moves in your favor), or volatility-based (calculated using indicators like ATR). The distance between your entry and stop loss directly affects your position size and risk-reward ratio.
You buy 100 shares of a stock at $50 and place a stop loss at $47. If the stock drops to $47, your position is automatically closed for a $3-per-share loss ($300 total). Without a stop loss, the stock could continue to $40 or lower, resulting in a $1,000+ loss. If you are risking 2% of a $15,000 account ($300), this stop loss placement is properly sized.
Stop losses are the foundation of risk management. They protect traders from catastrophic losses, emotional decision-making, and the temptation to hold losing positions hoping for a reversal. Every professional trader uses stop losses. Without them, a single bad trade can erase months of gains. Stop losses also define the risk component of your position sizing and risk-reward calculations.