Trailing stop orders are a form of stop-loss orders. Their main objective is to protect profits generated from trade. If used properly, a trailing stop can follow the increase in the price of an underlying asset in which it has been invested.
In other words, the trailing stop loss is a way to maximize your profits when the market moves in your favor and puts a stop that adjusts to the needs to get the most out of each order.
Let’s see a clear example with currencies
Forex Trailing stop order
Let’s say we have opened a buy order on the EUR/USD at 1.3156 and we have our stop loss at 1.3106, i.e. a stop of 50 ticks. If we use a feature called Trailing Stop Order, which many traders allow being set on every market order, we could for example set a Trailing Stop of 30 pips.
Forex trailing stop order would work as follows:
If the market moved in our favor 30 pips, for example up to 1.3186, our stop would move up 30 pips, and the order would maintain the original distance of our stop loss (for example 50 pips) from the current price.
This way, if the market were to fall, our stop would be higher than at the beginning, so we would lose less, or we would not be losing what we have already gained.
This strategy of using the trailing stop is very useful to ensure our profits in a given position when the market has moved in our favor and to accompany the profits in stretches defined by the trailing stop.
It should be understood that stop-loss has some good and bad characteristics as a system, first of all, it is difficult to apply to assets that are highly volatile (e.g. low liquidity stocks such as AHPI).
If stocks often move by 5% or more in a week and stop-loss is too close to the current price, it is possible that they will be sold to you even if you didn’t want them to. In these circumstances, a limit of 10% or more may be more appropriate. On the bright side, it is really necessary to protect your position at all costs.
Obviously, I advise a ‘trailing stop-loss’ to profit from the trend. This is a method of tracking the price of an asset and is designed so that you can let run your profits and reduce your losses.
Stocks trailing stop-loss order
Finally, I will give an example of stocks. To use a trailing stop-loss, you set a series of points or percentage below your current price. This will be your minimum in other words the automatic trigger to sell if the set price has been touched. However, as the stock price increases, your stop-loss moves up in the same proportion as the stock price.
Another example, you bought the shares of Moderna, a few weeks ago for $25 per share and have grown 23% in these weeks and are now at $38 per share.
You only have to use a “trailing stop”, which is a percentage below the market price to ensure that this gain does not turn into a loss. For example, you can set on your platform that you want a “trailing stop” 10% below the market price.
Trailing stop loss order on Stocks, for example:
Using our example, the trailing stop point is at $34.20 per share (38 x 10% = 3.80, 38 – 3.80 = 34.20).
If the share keeps going up, so will the trailing stop.
- $39 per share, the trailing stop is at $35.51
- $40 per share, the trailing stop is at $36.00
- $41 per share, the trailing stop is at $36.90
- $42 per share, the trailing stop is at $37.80
How to use the trailing stop-loss order?
The most typical one is to close the trade with a certain profit and not go looking for trailing stops of any kind. This is the most common and what most traders do. This way of trading also works with the right system.
However, some traders prefer to apply trailing stop techniques to chase the trend and make the most of it.
When using trailing stop loss we will be looking to get out of the trade at the most “efficient” moment. It’s very difficult to predict the way of the trend, but using the trailing stop loss, we try, and sometimes we get pretty close to that point, in which case a good trade usually comes out.
If you catch the good trend, then it’s usually the case that you don’t want to get out of it, until the market says it’s over. In those cases better apply trailing stops to maximize profits.
For example, a stock goes up by 40% and starts to correct a bit to go back up. In that case, you can try to put a trailing stop just below that small correction, with the aim of trying to make a good profit in case a bearish market comes and the stock price falls again.
Trailing stop loss can help you to protect profits while an asset is trending up and suddenly bad news emerges or it’s a big drop. There is no secret formula in this case, unfortunately.
It is rather a qualitative technique that will depend on quite a few variables.
And since it is something that depends on so many variables you will realize that there are several ways to use a trailing stop.
Trailing stop in day trading of Forex, futures, and CFDs
Countless traders try to use the trailing stop concept in their high-frequency trading.
In particular, the Forex world is really popular in this field, with its huge automated trading market and different scalping techniques.
The same goes for the futures market, where some traders sell the idea that by using trailing stops we will gain some important comparative advantage.
Traders think that intraday movements are essentially the same as medium and long-term trend movements, so according to these traders, the only difference is in the magnitude of the cycle, with many intraday ups and downs.
These scalpers are supposed to be scratching small profits from high-frequency moves and some of them even use the trailing stop technique. This technique together with scalping means that the scalper tries to follow the short-term movement while it is going on, and will only leave the trade when the price turns in the opposite way.
The problem is that in reality, day trading adds a series of complications that are difficult to overcome in the way of costs and trading and price behavior that make trying to apply this concept of trailing stop very complicated, at least in a way that will give us a “profit” to make money in the long term.
This tactic in day trading can be very complicated to apply, so it’s better to study first the complex movements of day trading before using it.
Trailing Stop Loss, conclusion
There is no perfect way to place a Trailing Stop order, but the one that makes the most sense is the one based on technical price analysis, and probably the one that makes the least sense is the one based on the current price.
Every investor has to find out what makes the most sense to him.
In theory, Trailing Stops are for trending markets, but it is only easy to discover trends if we look back when the movement has already occurred, so…in reality, it is a way to manage, not better, not worse…different.
Great traders beat the market by their “Pareto” rule (20/80) that is to say, 20 of their trades provide 80% of their profits. In addition, this method follows the basic principle of trading; cut the losses, and let the profits flow.