As long as the price of the underlying asset increases in the trader’s favor, a trailing stop order maintains a pre-determined maximum distance from its current price, known as the trailing stop distance. If the price moves in the opposite direction of the trader, the trailing stop will retain its position until it is struck, at which point a market order is executed.
What a trailing stop order is, in another way, may be described as follows: a stop order that pursues the current price by a certain distance as long as the price goes in your favor. It is important to note that we used the term “distance” since trailing stops may often be established with a specific number of distance points.
Using a trailing stop, an investor may safeguard profits by allowing a transaction to stay open and profitable as long as the price is going in the investor’s direction. Whenever the price moves in the opposite direction of the set percentage or dollar amount, the order terminates the deal. In most cases, a trailing stop is set up at the same time as the main transaction, although it may also be set up after the trade.
It is possible that some brokers may offer you the choice to set it in percentages or any other variation they can think of, but in the end, it will be distance points (remember, brokers love to oversimplify things and create friendly names).
How Do You Place a Trailing Stop Order?
Most beginner trading platforms do not offer the option for trailing stops, while others do, but they do not allow you to create a custom trailing stop order; instead, they simply offer “trailing stop-loss.” Professional trading platforms, on the other hand, allow you to create custom trailing stop orders, as well as choose the type of order (buy or sell) and any other parameters.
All you need to do to set up a trailing stop is the following:
• Select a predetermined distance from the current price that you are comfortable with.
• Place your purchase now.
The key is to be aware of the distance measurement system you’re employing. If your trading platform refers to a %, it is possible that they are referring to a percentage of the trade’s value, as in the following example:
• The trailing stop-loss of your transaction for $10.000 is 2 percent, which means that the trailing stop-loss will maintain an initial distance of $200 from the original price of the trade (whatever that price is).
• Distance measured in points, for example, 1 point might represent a 0.01 percent decrease in the asset’s market value.
• Other brokers may use a different point measure and claim that 1-point equals something else; thus, when establishing your trailing stop-loss order, be very cautious and verify the final price on the trading interface; they should display this amount.
• If the current price is $48.64 and the trailing stop-loss price is $48.59 after you input 1 point, you will know that 1 point translates to a difference of 0.01 in price from the current price.
The Advantages and Disadvantages of Trailing Stop Order
The primary benefit is as follows:
• Profitably locking in gains on a deal that is already lucrative while also allowing it the opportunity to amass more profits if feasible.
The primary drawback is as follows:
• The price can quickly hit your trailing stop and then continue in a favorable direction, which could have resulted in more profits for you. However, this is not a disadvantage of using a trailing stop-loss order; rather, it is the nature of the markets to do crazy things in combination with incorrect placement of a trailing stop-loss order, which is most likely too tight in this case.
When is it Appropriate to Employ a Trailing Stop Order?
The purpose of trailing stops is to protect your profits when you have a transaction that is going in your favor and you want to give it the chance to continue moving in your favor while guaranteeing that if it moves against you, you still get some benefit.
Consider the following scenario: you purchased a stock for $5 and did not place any stop-loss or take-profit orders to protect your investment. The stock is now trading at $15, and you decide to place a trailing stop-loss order at $10, resulting in a fixed distance of: $15-$10.
• $5
• 500 Bonus Points
• God knows what the broker with whom you’re trading wants to call that distance, but it’s still just $5 at the end of the day.
This suggests that there are two conceivable outcomes in this situation:
• It is possible that the stock drops below $10 and your transaction ends in profit (yay!), which is the worst-case scenario. You earned $5.)
• The more profits scenario is one in which the stock rises in value and the trailing stop-loss moves in lockstep with the price, maintaining a $5 distance as long as the asset continues to rise in value in your favor and until the asset falls and hits your trailing stop-loss at whatever new price it has reached.
Please keep in mind that trailing stops will ONLY MOVE IN YOUR FAVOR; otherwise, they will remain at their previous price.
Typical Trailing Stop Order Mistakes
The following are the most typical errors made while utilizing a trailing stop order:
• On a lost transaction, using a trailing stop-loss. The main objective is to utilize it to lock in gains on a winning deal; locking in losses doesn’t make much sense.
• Using excessively tight trailing stop-loss settings means that even a little price change might trigger your trailing stop-loss, closing your trade at a loss.
An Example of a Trailing Stop
Consider the following scenario: you purchased Alphabet Inc. (GOOG) for $1,000. When you examine previous rises in the stock, you will see that the price will often have a fall of 5% to 8% before beginning to rise again in value. These previous movements may be used to assist determine the % level to be used for a trailing stop in the future. It is possible that selecting 3%, or even 5%, is too restrictive. Given that even slight pullbacks tend to move more than this, the trade is more likely to be stopped out by the trailing stop before it has a chance to improve and go higher in the next few days or weeks.
Choosing a trailing stop with a 20% margin is overkill. According to previous patterns, the average pullback is around 6 percent, with larger ones reaching approximately 8%. A better trailing stop loss would be between 10% and 12% of the total loss. This allows the trader to move freely, but it also allows the trader to exit the market swiftly if the price declines by more than 12%. A decline of 10% to 12% is bigger than a regular pullback, indicating that something more substantial is taking place—primarily, that a trend reversal is taking place instead of a simple pullback.
If you choose a 10% trailing stop, your broker will execute a sell order if the price falls by 10% below the price at which you purchased the stock. This is worth $900. If the price of the stock does not rise over $1,000 after you purchase it, your stop loss will remain at $900. The price will hit $1,010, at which point your stop loss will be raised to $909, which is 10 percent below $1,010. If the stock climbs up to $1250, your broker will execute an order to sell if the price falls to $1,125. Because your trailing stop order is set at $1,125, in the event that the price lowers to that level and does not rise again, your broker will automatically execute a sell order on your behalf when the price falls to that level from $1,250.
What Role does Market Psychology have in my Trailing Stop Strategy?
During a quick price decrease, it is vital not to succumb to the desire to reset your trailing stop, or otherwise your effective stop-loss may end up being lower than you had planned. The same is true when you see momentum peaking on the charts, especially when the stock is hitting an all-time high. Reducing the size of your trailing stop-loss is suggested in this situation.
Establish how to determine the exit points of positions based on how cautious you are as a trader before making your decision. You may identify your profitability levels and tolerable losses if you have an aggressive trading style by using a less precise strategy, such as the placement of trailing stops based on fundamental factors. The ability to close out a position at any moment by putting a sell order at the market is something that all savvy traders have.