A trailing stop is a type of stop-loss order
3 min read
The trailing stop loss may be practiced with stock, options, and futures exchanges that support regular stop-loss orders. It is a variety of stop-loss order. A trailing stop-loss order is executed when the price of the trading asset drops by the trailing value which can be expressed in percentage or currency amount.
For example, you might place a trailing stop order to sell your stock with a trailing stop loss of 4%. When the stock dropped 4% from its nearest high the trailing stop order will be executed.
For example, assume that ABC stock is in its uptrend and hits $100 per share. If you placed a trailing stop loss of 4% it would be triggered when the price drops to $96 or below. Hence, your trailing stop loss at 96%, the sell order at $96 would be a market order. Instead, you can set a trailing stop limit which would provide you to gain a specified price placed in advance.
Also, instead of placing percentages you may enter a trailing stop loss in currency. It is more favorable. Let’s do some math.
Let’s say, ABC shares increase to $120, a $4 trailing stop would trigger at $116, which is a 3,3 % drop. If you entered a 4% trailing stop, it wouldn’t trigger until the shares fell 4% to $115.
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The mistakes about using a trailing stop
A typical mistake is to set a trailing stop too close to the current price. For example, 1% or 2% trailing stop loss. Most stock prices are changing by at least a few cents per minute. If you set the trailing stop loss too tied to the entry it will be stopped out before any significant price moves occurred.
The best way is to set a trailing stop distance enough from the current price. If you keep in mind that that the market regularly fluctuates inside a 10 cent span, you would like to set it a bit far from that amount. But be aware, if you set it more from that range because it could happen that you never reach the placed point. The consequence is that the trailing stop could be invalidated and never executed.
The point of using the trailing stop loss is to get you out of the trade if there is a high possibility of the price changing and destroying your profit on your trade.
Trailing stops are useful because they secure in profit when the price moves in our beneficial. The disadvantage is that sometimes they get us out of a trade when the price isn’t really changing, but simply pulling back a little. A good option to a trailing stop loss is to apply a profit target, have that in your mind.
How to move a trailing stop loss
It is easy to find a lot of brokers that provide this type of orders. It’s up to you to choose how much space you want to in your trade. Think twice would you like to set it in percentages or currencies (you have both examples above). When you confirm the order it will move as the market moves because that is the nature of trailing stops: to move as the prices move. You can set it automatically or manually.
Bottom line
Traders use different systems to improve their profits and diminish the losses. One of these methods is the trailing stop order. It allows you to define the circumstances that will trigger an order to exit your position. It safeguards your trade against unexpected downturns.
No matter if you are trading stocks, bonds or whatever, you must have a solid exit strategy. Moreover, you must have it before you buy the position. We already wrote about emotional trading. A good exit strategy will allow you to diminish fears. Let’s say your exit strategy is to wait for the price of your stocks to drop by 15%. You’ll be able to avoid trading in a panic if your stocks drop by 10%. That is the main purpose of applying a trailing stops and other stop-loss orders, to give you a plan to realize your exit strategy.
