How to limit potential losses

Stock markets are notoriously volatile. If you’ve invested even a small amount, you know that sinking feeling when a stock starts to fall. Few things are as unsettling as watching what seemed like a sure-fire winner suddenly turn your hard-earned cash into vapour. Fortunately, you don’t have to be at the mercy of the market—there are strategies that can help protect you.

One of the most effective tools is the humble stop-loss order, and it is best used right from the start of your investment. Once a stock begins to make a loss, emotions can cloud judgment. Beginners often second-guess themselves and stay in losing positions far longer than they should.

A stop-loss order prevents this by automatically selling your stock if the price falls to a predetermined level. Ideally, it should be set as soon as you buy—while your head is still cool and you can think clearly about how much you are willing to risk if the market turns against you.

The key question is how to choose the price level for your stop-loss so that you remain protected without being forced out too early by normal market volatility. The answer depends on the size of the company, your tolerance for risk, and your intended time horizon.

If your stock is a large-cap company, such as those in the FTSE 100, the DJIA, or the DAX, its daily range is usually fairly narrow—often between 1–5% or less. Smaller companies and startups, on the other hand, can swing 7–10% per day in either direction.

Many experienced fund managers set stop-losses around 7–8% below the purchase price for large- to mid-cap stocks. Research shows that if, for instance, you hold ten stocks and one delivers around 25% per year while the others move broadly in line with the market, you can afford for one stock to fall by 7–8% and still come out ahead over the year.

That said, we believe the approach should be more individual. For smaller investments, it often makes sense to use a tighter range. A good practice is to observe a stock for some time before committing, then tailor the stop-loss level to its behaviour and volatility.

For more, join our "Staying safe in the stock market" session, where we walk you through practical strategies for protecting your investments.