Stop Losses and Risk Management

Protecting Your Capital

Risk management is arguably the most important aspect of trading. You can have the best technical signals in the world, but without proper risk management, a few bad trades can wipe out months of profits. A stop loss is your primary tool for limiting downside risk.

What Is a Stop Loss?

A stop loss is a predetermined price level at which you will sell a stock to limit your loss. Before entering any trade, you should always know exactly where your stop loss will be.

Types of Stop Losses

Fixed percentage stop — Sell if the stock drops a set percentage from your entry (e.g., 5% or 8%). Simple but may not account for the stock's volatility.
ATR-based stop — Set your stop at 2x the ATR below your entry price. This adapts to the stock's natural volatility and avoids being stopped out by normal price fluctuations.
Support-level stop — Place your stop just below a key support level or a recent swing low. If the price breaks below support, the trade thesis is invalidated.
Trailing stop — A stop that moves up as the price rises but does not move down. It locks in profits while letting winners run.

The Risk-Reward Ratio

Before entering a trade, calculate your risk-reward ratio:

Risk = Entry price minus stop loss price
Reward = Target price minus entry price
Minimum ratio = Aim for at least 1:2 (risk KES 1 to potentially make KES 2)

With a 1:2 risk-reward ratio, you only need to be right 40% of the time to be profitable.

Position Sizing Rule

Never risk more than 1-2% of your total portfolio on a single trade. If your portfolio is worth KES 100,000, your maximum loss on any single trade should be KES 1,000 to KES 2,000. This ensures that even a string of losing trades will not devastate your portfolio.

Practical NSE Example

You buy KCB at KES 40. The ATR is KES 1.50. You set your stop at KES 37 (2x ATR below entry). Your target is KES 46 (based on the next resistance level). Risk = KES 3. Reward = KES 6. Risk-reward = 1:2. If your portfolio is KES 200,000 and you risk 1%, your maximum loss is KES 2,000, meaning you buy 667 shares (KES 2,000 / KES 3 risk per share).