Importance of stop loss and calculated risk reward in portfolio management

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How to decide the Stop Loss price?

There is no set rule on the price at which one should set a Stop Loss. Short-term traders tend to use Stop Losses of 2-5% whereas Long-term investors may set Stop Losses of 10-20%. It all depends on your risk tolerance.

ref https://www.fisdom.com/stop-loss/

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Scenarios comparing effects of a difference of 3% in stop loss levels on the net profit :

A. Scenario with 50 trades, position size of Rs 10000 each . loss making trades are 40% while profit making trades are 60%.

 loss incurred is 5% in 20% trades,

 loss incurred is 10% in 20% trades. 

while profits are as follows.

profit made is 15% in 30% trades. 

profit made is 20% in 30 % trades. 

The net profit/loss is calculated.

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To calculate the net profit or loss in this scenario, we first need to calculate the total loss and total profit made in each category of trades.


Loss incurred in 40% trades (20 out of 50 trades) at different percentages:


Loss at 5%: 20 trades * Rs 10,000 * 5% = Rs 10,000

Loss at 10%: 20 trades * Rs 10,000 * 10% = Rs 20,000

Total loss = Rs 10,000 + Rs 20,000 = Rs 30,000


Profit made in 60% trades (30 out of 50 trades) at different percentages:


Profit at 15%: 30 trades * Rs 10,000 * 15% = Rs 45,000

Profit at 20%: 30 trades * Rs 10,000 * 20% = Rs 60,000

Total profit = Rs 45,000 + Rs 60,000 = Rs 105,000


Net profit/loss = Total profit - Total loss = Rs 105,000 - Rs 30,000 = Rs 75,000


Therefore, the net profit in this scenario is Rs 75,000.

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B. Now, in the above trade set, if we change the stop loss by just 3% in loss making trades, without changing the profit percent in profitable trades. see what is the effect on profits:


Scenario with 50 trades, position size of Rs 10000 each . loss making trades are 40% while profit making trades are 60%.


 loss incurred is 8% in 20% trades,


 loss incurred is 13% in 20% trades. 


while profits are as follows.


profit made is 15% in 30% trades. 


profit made is 20% in 30 % trades. 


The net profit/loss is calculated.

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To calculate the net profit or loss in this scenario, we first need to calculate the total loss and total profit made in each category of trades.


Loss incurred in 40% trades (20 out of 50 trades) at different percentages:


Loss at 8%: 20 trades * Rs 10,000 * 8% = Rs 16,000

Loss at 13%: 20 trades * Rs 10,000 * 13% = Rs 26,000

Total loss = Rs 16,000 + Rs 26,000 = Rs 42,000


Profit made in 60% trades (30 out of 50 trades) at different percentages:


Profit at 15%: 30 trades * Rs 10,000 * 15% = Rs 45,000

Profit at 20%: 30 trades * Rs 10,000 * 20% = Rs 60,000

Total profit = Rs 45,000 + Rs 60,000 = Rs 105,000


Net profit/loss = Total profit - Total loss = Rs 105,000 - Rs 42,000 = Rs 63,000


Therefore, the net profit in this scenario is Rs 63,000.

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That's a difference of 12000 from Scenario 'A'.

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Scenario C.

Scenario with 50 trades, position size of Rs 10000 each . loss making trades are 40% while profit making trades are 60%.


 loss incurred is 5% in 20% trades,


 loss incurred is 10% in 20% trades. 


while profits are as follows.


profit made is 14% in 30% trades. 


profit made is 18% in 30 % trades. 


The net profit/loss is calculated.

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In this scenario, 20% of the trades result in a loss of 5% of the position size (Rs 10000), so each of these trades loses 5% * Rs 10000 = Rs 500. The total loss for these trades would be 20% * 50 trades * Rs 500 = Rs 5000.


Similarly, for the 20% of trades with a loss of 10%, the total loss would be 10% * Rs 10000 = Rs 1000 per trade. So, the total loss for these trades would be 20% * 50 trades * Rs 1000 = Rs 10000.


For the 30% of trades with a profit of 14%, the total profit would be 14% * Rs 10000 = Rs 1400 per trade. So, the total profit for these trades would be 30% * 50 trades * Rs 1400 = Rs 21000.


For the remaining 30% of trades with a profit of 18%, the total profit would be 18% * Rs 10000 = Rs 1800 per trade. So, the total profit for these trades would be 30% * 50 trades * Rs 1800 = Rs 27000.


Adding up all the profit and loss, the net profit or loss would be: Rs 21000 + Rs 27000 - Rs 5000 - Rs 10000 = Rs 34000, which indicates a net profit of Rs 34000.


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