Trailing stop orders are stop orders designed to set a price limit above or below the changing market price to either ensure profits or limit losses on active trading positions. Essentially, a trailing stop order is not too dissimilar from a regular stop order, which sets a stop price for the security. The main difference is that the trailing stop is more dynamic and enables traders to increase their returns.
Trailing stop definition
A trailing stop is an order type that allows traders to set a specified percentage or money amount of deviation from the changing market price.
This allows the trader to guarantee profits when the trade goes favourably, and limit losses when it does not.
Why is understanding Trailing Stop in trading important for traders?
- Trailing stops can be placed automatically or manually.
- AutomaticTrailing stops are a great tool in cases where traders cannot monitor their positions.
- Trailing Stops can increase traders’ income potential especially when market conditions are supportive.
- By using a trailing stop order, the trader can limit the downside of his/her position
- A trailing stop order can be denoted as a dollar value or as a percentage
The trailing stop order in more detail
When a trader buys a security and the trade deviates from the trader’s price goal, they have the option to create a safety net around the market price to limit potential losses, while locking in profits. Trailing stop orders are typically placed alongside the original trade, however, traders also have the option to place them separately.
Automatic Trailing Stop orders are more flexible than regular stop orders as they track the market price of security without the need for adjustments from a trader. In addition, traders can manually trail their stops, which has advantages over automatic ones. When manually levelling up the stops, traders can better select support and resistance levels and place the orders accordingly.
Trailing stops fail to be effective in high volatility. When prices move sharply, Trailing Stops tend to get triggered more often and instead of providing traders with increased profit potential, they cause losses. Trailing Stops are highly effective in calm and trending market conditions.
Trailing stop example in forex trading
Let’s assume a trader goes short on the EUR/USD pair at 0.9990, with a trailing stop of 20 pips. In case the trade goes in the opposite direction than what was predicted and reaches 1.0010, the order will get closed out and the losses will be 20 pips +trading fees. However, if the trade goes in the desired direction and reaches 0.9970, the stop-loss will shift to the original entry price of the trade at 0.9990, which limits possible losses on the position. Another move in the predicted direction will shift the stop loss target even further.
The biggest downside of trading with Trailing Stop is that the price might make a correction, trigger the order and continue moving towards the predicted direction. When using the order type, make sure the market is not volatile.
FAQs on the trailing stop
Is a trailing stop a good idea?
It depends on the market conditions. In calm and less volatile markets, trailing stops are a great idea. They work great in trending environments. In choppy markets, they tend to get triggered often causing account declines instead of bringing profits.
What is a good trailing stop percentage?
The best percentage depends on the asset type and market conditions. Generally traders are using 15-25% trailing stops. Keep in mind that you can use manual trailing stops and move your stop losses once price makes significant moves towards predicted direction.