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Using Trailing Stop Orders

What’s a Trailing Stop?

A trailing stop is a type of stop-loss order that assists a trader in both the management of risk and managing your trade. Trailing stops also help closing profits on trades while also limiting the amount that will be lost if the trade doesn't work out. Automated trailing stops should be available on direct access technology, or a trader can always manually move their stop orders as the price of the security rises or falls.

Trailing Stop Mechanics

A trailing stop basically operates in the same manner as a regular stop-loss order. If this was a long trade, a trailing stop would be an order to sell and placed at a price that was below the buy price. The difference between an ordinary stop loss and a trailing stop is that the trailing stop order will move as the price of the security rises or falls.

For every $0.25 that the price of your stock moves higher, your trailing stop order would also move higher by $0.25. However if your stock price begins to fall, your stop loss price will be static at the last price. This allows you to protect your profit as the stock moves higher.

If you open a position of XYZ Corporation (NYSE: XYZ) at $100, a 25 cent trailing stop would be placed at $99.75. When the price of XYZ shares move to $100.25, your trailing stop would move to $100.00. At $100.50, the trail would automatically price at $100.25. If the market pulls in a bit and the stock price falls to $100.40, your trailing stop would stay fixed at $100.25. Therefore with a 25 cent trail, the maximum loss / protected profit would be 25 cents from the high price.

This will work in reverse for a short trail stop. No need for a second example.

Trailing Stops: What Not to Do

Trailing stops sound like a great idea and an easy way to limit your risk and lock in upside profit in a rising market. What could go wrong? Eager traders often place their trailing stop orders too tight to their opening price. Unless you are extremely lucky in picking the perfect price, you won’t make any significant profit without taking on some degree of risk. Depending on the stock price and its Average True Range (ATR), most liquid equities are moving in ranges where a five cent stop loss or less will be triggered early. The purpose of a trailing stop is for it to trigger when there is a reasonable reversal in your time frame you are using.

Remember the pros and cons of a trailing stop. They help us realize profit as the security price moves in your direction. The negative is that because of limited human interaction, a trailing stop loss order won’t differentiate a pullback from a reversal and you could be stopped out early. One option in using a trailing stop loss is to use a reward target and a standard stop loss.

Entering a Trailing Stop Order

Many front end trading systems provide trailing stop orders. Do an analysis of the trade based on the current market conditions and decide how much rope to give it. The trail order should move as the price rises or falls. Remember that you aren’t lost if your technology doesn’t offer trailing stop functionality. Traders can also use stop loss orders manually. Just change the price of your order as the price rises or falls.

In Conclusion

Using trailing stops is a personal preference and a polarizing topic for experienced traders. Some traders never use them because they don’t like losing control over the trade and some traders would never place a trade without the security of a trail. If you are interested, first ask your software provider if they offer the functionality and if so, try it out on a few trades. Decide for yourself.

Sincerely,

Your Unbiased Source of Information Here at Score Priority

Nothing in this communication shall constitute a solicitation or recommendation to buy or sell a particular security. Accordingly, no representation or warranty, expressed or implied, is made as to, and no reliance should be placed on, the fairness, accuracy, completeness or timeliness of the information contained herein. Securities are offered through Score Priority Corp. Member FINRA/NFA/SIPC.

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