What is a stop loss order?

A stop loss is an order to close an existing position when the market reaches a certain price. It limits losses by automatically exiting a trade when the price moves against you by a specified amount. When the stop price is reached, the order converts to a market order and is executed at the next available price.

What is the difference between a stop loss and a stop limit order?

A stop loss converts to a market order when triggered, executing at the next available price, which could be worse than the stop price in fast markets or gaps. A stop limit order converts to a limit order when triggered, only executing at the limit price or better. The risk with stop limits is that the order may never fill if price gaps past the limit.

Should I use a stop loss on mean-reversion strategies?

Mean-reversion strategies often perform worse with tight stop losses because the edge increases as price moves further from the mean. Backtests frequently show mean-reversion strategies produce more net profit without stops. Trend-following strategies, by contrast, almost always benefit from a stop loss.

What is the best stop loss strategy?

There is no universal best stop loss. Testing across three strategies and eight stop types showed the $100 trailing stop was best for RSI and Turnaround Tuesday strategies but one of the worst for moving average crossover. Every strategy and symbol combination requires individualized testing to find the optimal stop type and distance.

Stop Losses: Complete Guide
and Test Results Reveal

Fixed dollar, percentage, ATR, and trailing stops, tested across 3 strategies and 8 stop types with real backtest data. Which stop loss works best? The answer will surprise you.

By David Bergstrom·Updated Feb 25, 2026·16 min read

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What Is a Stop Loss?

A stop loss is an order to close an existing position to limit losses when the market reaches a certain price. It is a form of risk management that automatically exits a trade when the setup has been invalidated or the trader cannot stomach more pain. The purpose: protect against severe losses before they happen.

Stop loss order basics diagram showing how a sell stop order limits downside risk on a long stock position by automatically closing at a preset price level — A stop loss automatically exits when price reaches your predetermined risk threshold

How Does a Stop Loss Work?

Cody buys 100 shares of AAPL at $104.00 and does not want to risk more than $200. He sets a stop loss at $102.00. If AAPL falls to that price, his 100 shares are automatically sold, capping his loss at $200.

Stop loss order colorized example showing Cody buying AAPL at 104 dollars with a stop loss sell order at 102 dollars limiting risk to 200 dollars on 100 shares — When AAPL hits $102.00, the stop converts to a market order and executes

When price reaches the stop, the order converts to a market order and executes at the next available price. If the best bid is $101.98 instead of $102.00, Cody's fill is $0.02 worse, a $202 loss instead of $200. This slippage risk matters in fast markets.

Stop Loss vs. Stop Limit Order

What if the best bid is $101.08 instead of $101.98? With a regular stop loss (market order), Cody sells at $101.08, a much larger loss. What if he'd prefer to wait for price to recover?

Stop Loss

→ Market Order

Triggers at stop price, executes at next available price. Guaranteed exit, but fill price may be worse than expected in fast markets or overnight gaps.

Stop Limit

→ Limit Order

Triggers at stop price, only fills at limit price or better. Controlled fill price, but order may never execute if price gaps past the limit.

⚠️ Gap Risk

Neither stop type protects against overnight gaps or thinly traded markets. A stock can close at $104 and open at $98, both stop loss and stop limit orders face execution risk in these scenarios. Trading liquid futures contracts can help alleviate some of this concern.

How to Calculate Stop Loss Placement

Where should the stop price go? There are three broad approaches, and the third is the only one we recommend.

Chart Patterns

Place stop beyond a recent high/low that invalidates the setup. Hard to backtest. We call this the "draw a line stop loss."

Risk Tolerance

Set stop at your personal pain threshold. Problem: the market does not care where your pain threshold is.

Something Testable ✓

Fixed dollar, fixed ATR, dynamic dollar, or rolling N-day low/high. Fully backtestable. This is the way.

Build Alpha chart pattern and stop loss placement example showing technical analysis stop below recent low with margin to avoid premature exit from volatile price action — Method 1: stop below a chart pattern level, intuitive but hard to backtest systematically

What Is a Trailing Stop Loss?

A trailing stop moves in the favorable direction as the trade becomes profitable but never moves backward. It protects against initial losses like a fixed stop, then locks in gains as the trade runs in your favor.

Trailing stop limit order example showing how the stop price automatically moves higher as the stock price rises locking in profits on a long position — The trailing stop rises with the stock, once it moves up, it never comes back down

Cody enters at $104.00 with a $1.00 trailing stop (initially at $103.00). AAPL rises to $104.77, the trailing stop moves to $103.77. If AAPL then rises to $105.66, the stop moves to $104.66, above his entry. Cody has locked in gains even if price drops. The trailing stop can update instantaneously or at the end of each bar.

Static vs. Dynamic Stop Losses

Static

Same Distance Every Trade

✓ Simple to understand and calculate

✓ Always know your exact risk

✗ Ignores changes in volatility

✗ Ignores changes in price level

Dynamic

Adjusts to Volatility

✓ Wider in high-vol, tighter in low-vol

✓ Adapts to price level changes ($50→$500)

✗ Harder to calculate on the fly

✗ Harder to quickly assess risk

Static vs dynamic stop loss comparison chart showing fixed dollar stop remaining constant while ATR-based dynamic stop widens and narrows with market volatility — Static stops stay fixed; dynamic stops breathe with volatility

Mean Reversion vs. Trend Following: Do Stops Always Help?

Not always. The answer depends entirely on the strategy type.

⚠ Stops Often Hurt

Mean-Reversion Strategies

When price moves further from the mean, the edge actually increases. A stop loss cuts the trade at peak edge. Backtests commonly show 2× more net profit without stops on mean-reversion systems.

✓ Stops Almost Always Help

Trend-Following Strategies

Trend strategies need a short leash for when the trend fails. Without a stop, a single losing trade can erase months of gains. Convex strategies almost always benefit from defined risk.

RSI Strategy: With Stop vs. Without

Here is a popular 2-period RSI strategy tested across SPY, DIA, QQQ, and IWM (buy when 2-RSI crosses above 20, sell when it falls below 80):

SPY 2-period RSI mean reversion trading strategy setup in Build Alpha showing buy signal when RSI crosses above 20 and sell signal when RSI drops below 80 — 2-period RSI strategy: classic mean-reversion setup on market ETFs

Comparison of 2-period RSI trading strategy equity curves with 1 percent stop loss versus no stop loss showing the no stop version producing 2x net profit in backtesting — Left: with $100 stop (1%). Right: no stop. The no-stop version produced 2× the net profit.

🔑 Key Insight

Neither version is great standalone, but the no-stop version doubled net profit. Mean reversion + tight stop = cutting your winner at the worst moment. This does not mean all strategies should avoid stops, the opposite is true for trend-following.

Position Sizing from Stop Distance

The late Dr. Van Tharp wrote extensively about calculating position size based on entry-to-stop distance. His complete guide on position sizing is a must-read. In short:

Account Size$100,000

Risk Per Trade2% = $2,000

Entry Price$104.00

Stop Price$102.00 (distance = $2.00)

Position Size$2,000 ÷ $2.00 = 1,000 shares

This method can produce large position sizes, and you may not get filled at exactly $102.00 in fast markets. Build Alpha supports this approach via its "Volatility" based position sizing, which dynamically sizes based on stop distance.

The Test: 3 Strategies × 8 Stop Types

Enough discussion. Let's look at real data. We tested three popular strategies, each with $10,000 per position, backtested 2006 to mid-2022 using Build Alpha.

Five Stop Loss Types

💵

Fixed Dollar Stop

Risk the same dollar amount every trade regardless of underlying price.

e.g. $100 or $200 per trade

📊

Fixed Percentage Stop

Risk the same percentage of position value each trade.

e.g. 1% or 2% of $10,000 position

📐

ATR-Based Stop

Risk a multiple of Average True Range. Dynamic, widens/narrows with volatility.

e.g. 1 ATR or 2 ATR below entry

📈

Trailing Stop (Dollar or ATR)

Follows price in the favorable direction. Protects gains as the trade runs.

e.g. $100 trail or 1 ATR trail

Eight Stop Configurations Tested

$100 Stop Loss (1%)

$200 Stop Loss (2%)

1 ATR Stop Loss

2 ATR Stop Loss

$100 Trailing Stop

$200 Trailing Stop

1 ATR Trailing Stop

2 ATR Trailing Stop

Three Strategies

Strategy 1

RSI 20-80

Buy when 2-period RSI crosses above 20, sell when it falls below 80. Mean reversion.

Strategy 2

Turnaround Tuesday

Buy stock index Tuesday after a down Monday. Seasonality-based edge.

Strategy 3

MA Crossover

Buy when 10-SMA crosses above 50-SMA. Classic trend-following.

Results

🏆 Key Results

The $100 trailing stop was the best performer for both RSI and Turnaround Tuesday, but it was one of the worst for the moving average crossover. There is no universal "best stop." Everything is relative to the strategy and symbols traded. You must TEST EVERYTHING.

There are tons of other variations we could test, combinations of stops, larger stops, smaller stops, time-based exits, and more. That is the beauty of Build Alpha, which allows you to quickly build and test strategies with no code.

Build Alpha dark mode interface showing algorithmic trading strategy results with equity curves and performance metrics for stop loss optimization and backtesting — Build Alpha's results interface, test countless stop variations with no code

Need to Know About Stop Loss Orders

Stop losses aim to protect traders from significant losses by automatically exiting at a preset price
A stop loss converts to a market order when triggered; a stop limit converts to a limit order
Trailing stops follow price in the favorable direction and protect gains as the trade progresses
Dynamic (ATR-based) stops adjust to volatility; static (fixed dollar) stops are simpler to calculate
Mean-reversion strategies are often harmed by stops; trend-following strategies almost always benefit
There is no universal best stop loss, each strategy requires individualized testing
Position sizing based on stop distance (Van Tharp method) dynamically sizes trades to your risk tolerance

Takeaways

✓ Key Takeaways

The $100 trailing stop won for 2 of 3 strategies but lost badly on the third, test everything
Mean-reversion strategies often produce 2× more profit without stops; trend-following needs them
Dynamic (ATR) stops adapt to changing volatility; static stops are simpler but may become outdated

💡 Need to Know

Stop loss → market order (guaranteed exit). Stop limit → limit order (price control, no fill guarantee)
Size positions from stop distance: Risk $ ÷ Stop Distance = shares to trade
Build Alpha tests all stop types across your strategies with no code, find the optimal exit for each system

Stop Loss FAQ

A stop loss is a sell order that triggers when price reaches a specified level, automatically closing your position to limit risk. It converts to a market order once the stop price is hit and executes at the next available price.

A stop loss converts to a market order (guaranteed exit, uncertain fill price). A stop limit converts to a limit order (controlled fill price, but may never execute if price gaps past the limit). The big risk with stop limits is thinly traded markets and overnight gaps.

A trailing stop follows price in the favorable direction but never moves backward. For longs, it trails below the highest price reached. It protects initial risk like a fixed stop, then locks in gains as the trade becomes profitable.

Mean-reversion strategies often perform worse with tight stops because the edge increases as price moves further from the mean. Backtests frequently show these strategies produce more net profit without stops. Trend-following strategies, by contrast, almost always benefit from a stop.

There is no universal best. Testing 8 stop types across 3 strategies showed the $100 trailing stop was best for RSI and Turnaround Tuesday but worst for moving average crossover. Every strategy and symbol requires individualized testing, which Build Alpha automates with no code.

There is no single right percentage. A stop should sit outside the stock's normal daily noise, so a volatile stock needs a wider stop than a quiet one. Swing traders often use 5% to 10% on stocks, but a stop based on volatility, such as a multiple of ATR, adapts to each stock. Size the position from the stop distance so the dollar risk per trade stays the same.

Calculate the average high-to-low range over the last 10 to 20 days, then place the stop a set fraction of that range away from entry, for example 50% to 100% of it. Test a few fractions in a backtest rather than picking one by feel, and recalculate the range as volatility changes.