Trailing Stop Order - What is it and How to Use it?
By Stefano Treviso, Updated on: Apr 07 2023.
Table of Contents:
- Trailing Stop Order Explained
- How to Place a Trailing Stop Order
- Advantages and Disadvantages of the Trailing Stop Order
- When should you use a Trailing Stop Order?
- Common Trailing Stop Order Mistakes
Trailing Stop Order Explained
A trailing stop order is a dynamic stop order that maintains a pre-set maximum distance from the current price as long as it moves in the trader’s favour. If the price goes against the trader, the trailing stop will hold its position until it get hits and then a market order will be executed.
Another way to summarize what a trailing stop order is could be: a stop order that chases the current price by a fixed distance as long as it moves in your favour.
Notice we used the word distance and that is because trailing stops can be set usually with a fixed amount of distance points.
Some brokers might give you the option to set it in percentage or any modification they can think of, but it the end it will become distance points (remember, brokers love to oversimplify things and create friendly names).
An example of using distance is: 0.30 from the current price.
If you set a trailing stop-loss with a distance of 0.30 and the current price is $50 then your trailing stop’s trigger price will be initially $49.7 and then every time the current price of the asset climbs $0.1 then the trailing stop will also climb maintaining that 0.30 distance.
Continuing our example, if the price climbs to $50.3 then our trailing stop-loss order will climb to $50. Now, if the price falls to $50.25 then what happens to the trailing stop-loss?
ABSOLUTELY NOTHING, STAYS AT ITS LAST POINT.
And that’s what you need to get, the trailing stop moves forward only in your favour and if the asset stops moving in your favour then the trailing stop-loss stays stuck until it gets hit.
The animation above is a pretty cool visual example of a trailing stop-loss order, look at it for several seconds, notice how when the price moves up it moves up also, but when the asset’s price begins to fall it stays exactly at it’s latest point and boom, trade closed.
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How to Place a Trailing Stop Order
Most beginner trading platforms don’t have the option for trailing stops, others do have it but it’s not a custom trailing stop order, they just offer “trailing stop-loss” and then there’s professional trading platforms that allow you to set trailing stop orders, chose the type of order (buy or sell) or any other parameters.
To place a trailing stop all you need is:
- Chose a fixed distance from the current price
- Place your order
The trick lies in knowing the distance measure you’re using. If your trading platform mentions percentage then they could be referring to a percentage of the trade’s value, for example:
- 2% Trailing stop-loss of your trade worth $10.000, so the trailing stop-loss will hold an initial distance of $200 from the original price (whatever that price is).
- Distance in points, for example: 1 point could mean 0.01 in price value of the asset.
- Other brokers could change this point measure and say that 1 point means something else, try to be very careful when you’re setting your trailing stop-loss order and check the final price in the trading platform, they should output this value.
- If the current price is $48.64 and after you enter 1 point that the trailing stop-loss price is $48.59 then you know that 1 point equals to 0.01 price difference.
Advantages and Disadvantages of the Trailing Stop Order
The main advantage is:
- Locking in profits on an already profitable trade and giving it the chance to accumulate more profits if possible.
The main disadvantage is:
- The price can quickly hit your trailing stop and continue then in a favourable direction which could have yielded you more profits, but again, this is not a disadvantage of the trailing stop-loss order, it’s the nature of the markets to do crazy stuff combined with incorrect placement of a trailing stop-loss, probably too tight.
When should you use a Trailing Stop Order?
Trailing stops are meant to be used when you have a trade in profit and you want to give it the opportunity to keep moving in your favour while ensuring that if it goes against you, you cash in some profit.
Use the example above to imagine that you bought a stock at $5 and you didn’t set any stop-loss or take profit orders.
Some time passes and the stock is trading at $15, then at that precise moment you decide to set a trailing stop-loss order at $10, meaning that your fixed distance is:
- $5
- 500 Points
- God knows whatever the broker you’re trading with wants to call that distance, but still in the end $5.
That means that there are 2 possible outcomes here:
- The worst case scenario is that the stock drops to $10 and your trade closes in profits (yeah! You made $5)
- The more profits scenario where the stock moves up and the trailing stop-loss follows the price maintaining that $5 distance as long as it keeps climbing in your favour and until the asset falls and hits your trailing stop-loss at whatever new price it is.
Remember, trailing stops ONLY MOVE in your FAVOUR, in any other case they get stuck on their last price.
Common Trailing Stop Order Mistakes
The most common mistakes when using a trailing stop order are:
- Using a trailing stop-loss on a losing trade. The whole point is to use it on a profitable trade to lock in profits, locking in loses doesn’t make much sense.
- Using very tight values for your trailing stop-loss that a very small price movement can simply trigger your trailing stop-loss and close your trade at a loss.
Hope you liked our guide,
Enjoy!