Trailing Stop Order

What is a Trailing Stop Order?

A powerful ally in the arsenal of a trader, “what is a trailing stop order?” is a question often asked by those looking to protect profits and limit losses. This order type automatically keeps pace with the market, making it a smart move for many traders. In this article, you will explore how and why a trailing stop order could be your smart move, with an insightful walkthrough from its basic mechanism to tactical application without overwhelming you with technical jargon.

Key Takeaways

  • A trailing stop order is an automated trade execution tool that protects gains by adjusting the trigger price as the market priceof an asset rises, but remains unchanged if the price falls, thereby helping to limit potential losses.
  • Trailing stop orders can be set as a percentage or a fixed dollar amount from the market price, offering flexibility and risk management according to individual trading strategies, especially in volatile markets.
  • While trailing stop orders automate the selling process and aid in managing risk and exits, they may be prone to slippage and are not guaranteed to execute at the set trigger price, particularly during fast market fluctuations or gaps.

What is a Trailing Stop Order?

Illustration of a stock market chart with a trailing stop order

What is the fundamental concept of a trailing stop order? A trailing amount is used in a conditional order to trigger the submission of a market order based on specific conditions. This allows for flexibility in executing trades. It’s designed to protect profits by remaining active during favorable market movements. The beauty of this tool lies in its automation. The trailing stop order adjusts according to market movements, recalculating the trigger price as the inside bid price reaches new highs. However, if the price stays the same or falls, it maintains its current trigger price.

Traders utilize trailing stop orders as an exit strategy, which aids in managing profits and losses in rapidly fluctuating markets. When the declining bid price falls below the trigger price, it will initiate a market order to sell. This action is designed to help mitigate potential losses. Traders have the flexibility to execute trailing stop orders as either limit or market orders, offering a degree of control over how their positions are managed.

Setting Your Trailing Stops: The Basics

Effectively utilizing this strategy necessitates the setting of a trailing stop loss. The trailing stop loss is set at a specified percentage below the market price, enabling a trade to remain open and profit as long as the stock price moves favorably. When you set a trailing stop loss, you specify a stop-loss percentage below the market price that adjusts as the price moves.

Consider a scenario where you set a trailing stop loss order at 10% below the purchase price. As the share price rises, the trailing stop will ratchet up, maintaining that 10% distance. This means the gap between the current market price and trigger price will change as the stock price fluctuates.

Percentage vs. Dollar Amount

You can set your trailing stop orders in two primary ways: either by specifying a percentage or a dollar amount. This level of customization allows traders to align their trailing stop orders with their individual trading strategy.

Let’s look at a trailing stop set at a fixed percentage distance from the market price. This type of trailing stop adjusts proportionally with price movements, which can be especially beneficial during periods of significant price changes. Whether you choose a percentage or a fixed dollar amount will influence the distance between the market price and the triggered stop loss price.

The Mechanics of Movement

How does the motion of a trailing stop order align with the market? The key lies in its automatic adjustments relative to the current price of a stock. As the market price of an asset increases, the trailing stop loss order adjusts accordingly, maintaining a predefined distance below the market price.

However, if the share price begins to fall, the trailing stop order remains stationary, preserving the set distance from the highest price attained. Thus, the stop price in a trailing stop order increases with the share price but will not decrease if the share price falls, limiting losses while maintaining the potential for upside gains.

Strategic Use of Trailing Stop Orders

Illustration of a trader managing risk with trailing stop orders

In the dynamic realm of trading, the strategic implementation of trailing stop orders can significantly alter the game. They are particularly beneficial in volatile markets, where price fluctuations can be rapid and significant. Trailing stop orders provide a way to lock in profits when a stock’s price is moving favorably and also mitigate losses during sudden price drops. By automating the adjustment of stop loss levels, trailing stop orders help traders solidify their risk management strategy and reduce potential emotional decision-making related to fear or greed.

Balancing the capture of profits while maintaining the capacity for additional gains if the stock price continues to rise is a delicate act, one that trailing stop orders can assist with. Additionally, trailing stop orders facilitate effective trend following and the development of exit strategies, ensuring traders can stay aligned with a stock’s momentum and manage exits more efficiently.

Timing and Market Sessions

In the realm of trading, the importance of timing cannot be overstated. Trailing stop orders are designed to trigger only within the standard market hours, which are in effect from 9:30 a.m. to 4 p.m. ET. This means that they are not triggered during pre-market or after-hours sessions, nor during times when the market is closed.

Importantly, trailing stop orders, including sell order types, can be placed as day orders, expiring at the end of the current market session, or as good-till-canceled (GTC) orders, remaining effective across multiple standard market sessions if not triggered.

Risk Management and Exit Strategies

Trailing stop orders significantly contribute to risk management, an integral aspect of trading. The key to managing risk with a trailing stop is to balance the position’s room to move favorably against the need to protect against significant losses. Traders should adjust trailing stops to lock in profits when prices move in their favor and consider wider stops in volatile markets to avoid being prematurely stopped out of their position.

Trailing stop orders provide an automated risk management method by setting an automatic selling point, which can minimize losses by selling assets once prices decline beyond a certain level. They act on behalf of the trader, executing automatically once the asset hits the specified trailing stop criteria, thus relieving the need for constant market monitoring. Integrating a traditional stop loss order with a sell trailing stop order makes for a more robust exit strategy, leveraging the benefits of both.

Some advantages of trailing stop orders include:

  • Minimizing losses by automatically selling assets when prices decline beyond a certain level
  • Eliminating the need for constant market monitoring
  • Allowing for a more robust exit strategy when combined with a traditional stop loss order

By utilizing trailing stop orders to limit losses, traders can effectively manage their risk and protect their investments.

Potential Pitfalls of Trailing Stops

Illustration of potential pitfalls of trailing stops

Despite their potential pitfalls, trailing stops serve as potent tools. One such pitfall is slippage, meaning the execution may not occur at the precise level set by the trader. During periods of high trading volume and fast market fluctuations, the execution price of a trailing stop order may differ from the expected price, especially when the market moves in the opposite direction. Large orders may experience price variation for different parts of the order due to liquidity issues.

Another issue is the vulnerability of trailing stops to market gaps, which can lead to slippage or execution at an unintended price. Pricing gaps that occur between trading sessions or during trading pauses can make trailing stops vulnerable, leading to execution prices that differ significantly from the stop’s trailing amount or trigger price.

Moreover, if there is no market for a security or if trading is halted, the market order triggered by a trailing stop cannot be executed, potentially resulting in a losing trade.

Real-World Examples: Trailing Stop Orders in Action

Illustration of real-world examples of trailing stop orders in action

Consider an actual example of a trailing stop order in operation. A trader used a trailing stop order to manage a long position in EURUSD. The initial trade was entered at 1.17366, with a stop distance set at 25 pips and a trailing stop at a distance of 5 points. As the price of EURUSD increased, the trailing stop was adjusted automatically to maintain the set distance.

Eventually, the position was closed out at 1.17816. This example illustrates the trailing stop order’s role in securing profits and limiting risk, but also highlights that such orders are not guaranteed and are subject to slippage.

Navigating the Trade Ticket: Placing Your Order

How should one go about placing a trailing stop order? To initiate a trailing stop order, traders should select the ‘trailing’ option in the stop drop-down menu on the trade ticket. After choosing the trailing stop option, the trader must specify the stop loss level and the desired trailing distance in the appropriate fields. However, it’s important to note that trailing stops are not available for working orders and are not guaranteed, potentially leading to slippage and not executing at the planned stop loss level.

Optimizing Trailing Stops with Market Insights

Illustration of optimizing trailing stops with market insights

Traders can gain a considerable advantage by optimizing the use of trailing stops. Traders may set more effective trailing stops by acknowledging the psychological impact of market movements and investor emotions, particularly the tendency to avoid losses more than seeking gains. Regular adjustments of trailing stop parameters, considering factors such as market whipsaws and long-term investment objectives, can improve the effectiveness of the strategy.

Effective trailing stop levels take into account the typical price fluctuations of a stock, which can be gauged through a careful analysis of stock behavior and relevant news that may impact volatility. Technical indicators such as moving averages and the average true range can be utilized to set trailing stop levels that correspond with different market trends, including short-term, medium-term, and long-term trends.

Advanced Techniques: Pairing Trailing Stops with Other Orders

Advanced traders have the option to designate trailing stops as either a limit or a market order. This activates when the price of a security changes direction by a preset dollar amount or percentage. This flexibility allows traders to tailor their use of trailing stops to their specific trading strategy and market conditions.

For instance, a trader might use a trailing stop as a limit order when they anticipate a significant upward price movement, locking in profits as the price rises, while a market order might be used when the trader expects a downward trend and wants to limit their losses.

Related reading: Bracket order


In the dynamic world of trading, risk management is key, and trailing stop orders offer a powerful tool to navigate this landscape. These orders dynamically adjust to market movements, protecting profits and mitigating losses. They offer flexibility, allowing traders to set stops based on either a percentage or a dollar amount, and their automatic nature relieves the need for constant market monitoring. However, they are not without their pitfalls, including the risk of slippage and vulnerability to market gaps.

Despite these potential challenges, the strategic use of trailing stop orders, particularly in volatile markets, can help traders manage risk and develop robust exit strategies. Paired with other order types or used in conjunction with market insights and technical indicators, trailing stops can enhance a trading strategy, helping traders to navigate the markets more efficiently and effectively.

Frequently Asked Questions

What is a trailing stop order?

A trailing stop order is a conditional order that uses a trailing amount to determine when to submit a market order, helping to protect profits during market fluctuations.

How do I set a trailing stop order?

To set a trailing stop order, simply select the ‘trailing’ option on the trade ticket and specify the stop loss level and desired trailing distance. This will help you protect your profits and limit potential losses.

When are trailing stop orders triggered?

Trailing stop orders are triggered only during standard market hours, from 9:30 a.m. to 4 p.m. ET. They do not trigger during pre-market or after-hours sessions.

What are some potential pitfalls of trailing stop orders?

The potential pitfalls of trailing stop orders include slippage, where the execution may not occur at the set level, and vulnerability to market gaps causing execution at an unintended price. Be mindful of these when using trailing stop orders.

How can I optimize my use of trailing stop orders?

To optimize your use of trailing stop orders, acknowledge the psychological impact of market movements, adjust parameters based on market trends, and use technical indicators to set appropriate levels. This will help you make strategic decisions and manage risks effectively.

Similar Posts