How to Use a Trailing Stop

Overview: Trailing Stop

A trailing stop is a type of stop order that can be issued at a percentage or dollar amount distant from the current market price of a security. For a long position, a trailing stop loss is set below the current market price. A short trade’s trailing stop is set above the current market price.

A trailing stop is a sort of stop-loss order that permits a trade to remain open and profitable as long as the price moves in the investor’s favor. The order closes the trade if the price changes direction by a specified percentage or dollar amount.

Traders can improve the effectiveness of a stop-loss order by combining it with a trailing stop, which is a trade order in which the stop-loss price is set at rather than a single, absolute dollar number, a percentage or dollar amount below the market price.

Why Should You Use Trailing Stops?

A trailing stop might be beneficial to traders who lack the discipline to lock in profits or cut losses. It takes away some of the emotion from trading by automatically safeguarding your funds.

You should think about the amount of your trailing stop extremely carefully. The stop level may be triggered frequently if you’re trading a particularly volatile currency pair (or other asset). Excessive trading can rapidly devolve into “churning,” with transaction fees (and commissions) eating away at your earnings.

What is the purpose of a trailing stop loss and how do you use it?

This is how it goes. When the price goes up, the trailing stop goes up with it. The new stop-loss price remains at the level it was dragged to when the price finally stops climbing, automatically safeguarding an investor’s downside while locking in profits when the price achieves new highs.

A trailing stop loss is set up in the same way as a standard stop-loss order. For example, if we were to place a trailing stop for a purchase order, we would do so below the trade entry price. The primary distinction between the two is that the trailing stop loss moves along with the price. For example, if the price moves five points, the trailing stop loss will also move five points.

Due to price changes and the volatility of certain equities, trailing stops are more difficult to use with active trades, especially during the first hour of trading. Fast-moving equities, on the other hand, tend to attract traders because of their ability to create large sums of money in a short period of time.

Benefits of a Trailing Stop:

When share prices fall, this order type will automatically sell your stock. Your gains are unaffected by this order. As long as prices do not fall below your stop loss, shares can continue to climb, and you will remain invested. The order can be changed at any time. For a personalized risk management plan, you can enter any trailing stop-loss % and alter it as needed. Placing a stop-loss order does not incur any additional charges. This order allows traders to remove their emotions from their trades.

Trailing Stop’s Drawbacks:

There is no certainty that the price of your stop-loss order will be met. Stop-loss orders for certain equities or exchange-traded funds are not permitted by some brokers (ETFs). With these orders, trading volatile equities are tough. When the stock price falls, you may lose the ability to make a thoughtful and analytical decision about whether or not to sell it.

Final Thoughts

Although there are considerable dangers associated with utilizing trailing stops, combining them with regular stop-losses can help safeguard earnings and minimize losses.