For example, If I bought Nifty at 6532 and want to book a 15 point profit, what would be my Stop loss assuming the trend is bullish.
So, one has to follow the following steps to actually define a Stop Loss:
First, Find a strategy that suits your style, get it back tested and jot down the %ge of success with the particular trading style. Second, Decide on your trading capital, and what %ge of trading capital you want to take the trade. Third, define your Risk Reward ratio i.e. in other words, define your 'Calculated Risk' Capacity or ratio of Target to Stop Loss.
Let me explain with two scenarios. For both the scenarios, following assumptions are made: 1. Margin required for trading is 30000 2. My trading style is successful 60% of the times.
Scenario 1: [Risk Reward Ratio is 1:1] Trade with a target of 15 points and Stop Loss of 15 points. This means 6 times i make 15 points profit [6*15 = 90] and 4 times i book 15 points loss [4*15 = 60] with stop loss. So, i make 30 points net [or Rs.1500] in every 10 trades, with an investment of 30000. Return on Investment is 5% in this case.
Scenario 2: [Risk Reward Ratio is 2:1]: Trade with a target of 15 points and Stop Loss of 8 points. This means 6 times i make 15 points profit [6*15= 90] and 4 times i book 8 points loss [4*8=32] with stop loss. So, i make 58 points net [or Rs. 2900] in every 10 trades, with an investment of 30000. Return on Investment is 9.7% in this case.
One has to define the Risk Reward ratio and then define the stop loss. This is an important money management skill a trader can have.