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Deciding your exit before you enter — the trade that stops small losses from becoming big ones.
Position sizing decides how much capital goes into a trade — but it only works if there's an actual stop-loss to measure that risk against. This lesson covers the other half of the equation: where to place a stop-loss, and how to judge whether a trade is even worth taking in the first place using risk-reward ratio.
A stop-loss is a predetermined price at which a losing trade gets exited automatically, capping the loss before it grows larger. It's placed the moment a trade is entered, not decided on the fly once the trade starts moving against you — deciding it in the moment almost always leads to holding on too long, hoping for a reversal that may never come.
Illustration
A trader buys a stock at ₹500, expecting it to rise toward ₹540 based on a resistance breakout. Before placing the trade, they set a stop-loss at ₹485 — just below the recent support level covered in an earlier lesson. If the stock falls to ₹485, the position exits automatically, capping the loss at ₹15 per share. Without that stop-loss in place beforehand, a sudden drop could easily turn a planned ₹15 loss into a much larger one while the trader hesitates.
A stop-loss isn't picked at a round number or a fixed rupee amount — it's placed at a level where the original reason for the trade would no longer hold true. Common reference points include just below a recent support level, just below a recent swing low, or a fixed percentage away from entry that matches the stock's typical volatility. If price reaches the stop-loss, it usually means the setup that justified the trade has failed, not just that price moved briefly against it.
Risk-reward ratio compares how much a trader stands to lose if the stop-loss is hit against how much they stand to gain if the target is reached. It's calculated before entering a trade, and it's one of the fastest ways to judge whether a setup is even worth taking.
| Risk-Reward Ratio | Win Rate Needed to Break Even |
|---|---|
| 1:1 | 50% |
| 1:2 | 33.3% |
| 1:3 | 25% |
This is the single most underrated idea in trading: a trader doesn't need to be right most of the time to be profitable — they need their winners to outweigh their losers by enough. At a 1:3 risk-reward ratio, being right just 25% of the time is enough to break even, and anything above that is profit. This is exactly why experienced traders obsess over risk-reward before every entry, often more than they obsess over being "right."
Illustration
A trader enters at ₹500 with a stop-loss at ₹485 (₹15 risk) and a target of ₹545 (₹45 reward) — a 1:3 risk-reward ratio. Out of 10 such trades, even if only 3 hit the target and 7 hit the stop-loss, the math works out in the trader's favor: 3 wins × ₹45 = ₹135 gained, 7 losses × ₹15 = ₹105 lost, a net profit of ₹30 — despite being wrong 70% of the time.
1. Moving the stop-loss further away once a trade goes wrong
Shifting the stop-loss to "give the trade more room" after it starts losing defeats its entire purpose — it turns a planned, capped loss into an unplanned, open-ended one.
2. Taking trades with a poor risk-reward ratio
Entering a trade risking ₹30 to make ₹20 (worse than 1:1) means needing to be right more often than not just to break even — a high bar that's hard to clear consistently.
3. Exiting winners early but letting losers run
Booking small profits out of fear while hoping losing trades will recover reverses the entire risk-reward setup a trader planned before entering — turning good math into bad results.
Key Takeaway
A stop-loss is decided before entering a trade, at the point where the original setup would no longer be valid — not adjusted emotionally once a trade is already losing. Risk-reward ratio measures potential loss against potential gain, and a favorable ratio means a trader can be profitable even while being wrong more often than they're right, which is why it matters just as much as being right in the first place.
Many traders aim for at least 1:2, meaning the potential reward is at least twice the risk — though the "right" ratio also depends on how often that particular strategy tends to win.
Yes, but only in one direction that's generally considered good practice — moving it closer to lock in profit as a trade moves favorably. Moving it further away to avoid taking a loss is the mistake to avoid.
No — it improves the odds of being profitable over many trades, but it doesn't guarantee any single trade will win. It's a probability tool applied across a series of trades, not a certainty for one.
A trailing stop-loss automatically moves closer to the current price as a trade moves in the trader's favor, locking in gains along the way while still giving the trade room to keep running.
Yes — as covered in position sizing, the distance between entry and stop-loss directly determines how many shares can be bought within a fixed risk budget, so the two are always calculated together.
Usually because they don't follow the plan consistently — moving stop-losses, cutting winners early, or skipping the stop-loss altogether undoes the math a favorable risk-reward ratio depends on.