Stop losses: how to use them and when

A stop loss is one of those tools that sounds more complicated than it is. Once you understand what it actually does, whether it belongs in your investing toolkit depends entirely on your strategy and how you think about managing risk.

The basic idea is simple. A stop loss is an instruction you place with your broker to sell your shares automatically if the price falls to a level you specify. If you buy shares at 200p and set a stop loss at 170p, your broker will sell if the price drops to that point. You do not need to be watching a screen. The order fires on its own.

The appeal is obvious. Markets can move fast, and a sharp fall in one holding can do serious damage to a portfolio if you are not paying attention. A stop loss acts as a floor. It says: this far, and no further.

There are a few different types worth understanding. The most common is a standard stop loss, sometimes called a hard stop. You set a specific price, and if the shares hit it, they are sold at the next available price. That next available price might not be exactly what you set, particularly if the market has jumped downward overnight or a piece of news has hit before trading began. This is called gapping, and it is the main limitation of the basic version.

A trailing stop loss works differently. Instead of a fixed price, it adjusts upward as the share price rises. If you set a trailing stop 15% below the current price and the shares move from 200p to 240p, the stop moves up to 204p. If the price then falls, the stop holds at its highest point. This is a useful way to protect gains without manually adjusting your instruction every time the shares move higher.

A guaranteed stop loss costs a small premium, usually charged as a slightly wider spread, but it does exactly what the name suggests: your shares will be sold at precisely the price you set, even if the market gaps through it overnight. This is the only version that truly eliminates gap risk. It is available on most major UK platforms including Hargreaves Lansdown and IG, though not all brokers offer it and not all shares qualify. For volatile or higher-risk positions, it is worth the extra cost.

The strongest argument for using a stop loss is emotional rather than technical. One of the most consistent mistakes among private investors is holding on to losing positions far longer than they should, waiting for a recovery that may never arrive. A stop loss takes the decision out of your hands before the loss becomes a serious problem. It does not require willpower, and it does not require you to admit you were wrong. It simply executes when the price reaches the level you set.

Stop losses also make particular sense for more volatile shares where a single piece of bad news can send the price sharply lower, and for any leveraged positions where losses can compound quickly. If you are holding smaller companies, speculative stocks or anything you would describe as carrying higher risk, a stop loss is a sensible part of managing that exposure.

That said, they are not a universal solution, and the problems begin with volatility. Share prices rarely move in a straight line. A stock you believe in for the long term might fall 15% on a disappointing set of results and recover fully within a few weeks. If you had a stop loss set at that level, you would have been sold out at precisely the wrong moment, watching the recovery from the sidelines with nothing to show for it.

This is why many long-term investors, particularly those running buy-and-hold strategies, do not use stop losses as a regular tool. They view short-term price noise as irrelevant to their investment case, and they are willing to sit through drawdowns that would trigger a stop. For them, the risk is not that a stop fires too slowly but that it fires too early.

Where you set the stop matters enormously. Set it too close to the current price and it will trigger on ordinary daily price movements, turning a long-term position into an expensive series of short-term trades. Set it too far away and it offers no meaningful protection. A common starting point is somewhere between 10% and 15% below the purchase price for more stable shares, and tighter for speculative positions, though there is no single correct answer. Some investors place stops based on technical levels in the chart, just below a support zone, rather than choosing an arbitrary percentage.

It is also worth being clear about what a stop loss does not do. It protects against falls but nothing else. It will not help you if the market rises sharply and you miss a point where you should have taken some profit. It will not rebalance your portfolio. It is a single-purpose tool with one job: limiting downside.

Used thoughtfully and placed at sensible levels, a stop loss can remove some of the emotion from investing and give you a clear exit point before things go seriously wrong. Used without thought, it can shake you out of good positions at the worst possible moment. Like most investing tools, it works well for people who understand what it is actually for.

TL;DR — the short version

• A stop loss automatically sells your shares when the price drops to a level you specify.
• Trailing stops move upward as the share price rises, progressively locking in gains.
• Guaranteed stops prevent gap risk but come at a small premium, and are worth it for volatile positions.
• The main benefit is removing emotion from the decision to cut a losing position.
• Set a stop too close to the current price and normal market fluctuations will trigger it unnecessarily.
• Long-term buy-and-hold investors often skip stop losses entirely, treating short-term volatility as part of the strategy.

Disclaimer: The value of investments can go down as well as up, and you may get back less than you invest. This article is for informational and educational purposes only and does not constitute financial advice. Always do your own research and consider seeking independent advice before making any investment decision.