Risk can be reduced with the use of a trailing stop loss. In contrast to standard stop-loss orders, which remain in place at a predetermined price, trailing stop-losses move in tandem with the price as it begins to trend in the desired direction. This helps to manage risk by restricting the potential downside while locking in any potential profit as the stop-loss tracks the trend of the market price as it moves in your favor.
Here you may get information about trailing stop-loss orders, how to use them, and some examples of how to put them up on our Next Generation trading platform.
What exactly is a trailing stop?
A stop-loss order is a type of order that allows you to finish a trade at a predetermined price if the market swings against you. Limiting your exposure to potential loss is the primary advantage of utilizing a stop-loss. Stop-loss orders will stay in place until either your trade is closed or you revoke the order.
A trailing stop, also known as a trailing stop-loss order, is a market order in which the stop-loss is not fixed to a precise dollar amount but rather a percentage of the asset’s current market price. The stop-loss order then follows the stock’s price as it fluctuates.
How does a trailing stop work?
You can use a trailing stop to protect your winnings and stay in a trade until the underlying instrument reaches your stop loss. You can choose a fixed number of points or a percentage change from the starting price for your trailing stop-loss order. Your transaction will be closed automatically when the market price hits your trailing stop.
If the market price first increases in your favor but then reverses, a trailing stop can be preferable to a standard stop-loss because your stop-loss will have tracked the positive price changes but not the negative ones. Like a traditional stop-loss, a trailing stop-loss will cause your transaction to be closed at the next available price if the price of the asset reaches your predetermined loss level, protecting you from further financial loss.
Using a trailing stop-loss and when to do it
A trailing stop-loss might be helpful in forex trading, for instance, when dealing with a highly volatile currency pair known for its extreme price swings. However, keep in mind that increased volatility could cause your stop-loss to be activated prematurely.
The stock’s past performance and current market conditions are crucial factors to consider when deciding where to set the trailing stop-loss. The market’s volatility throughout time, as well as its day-to-day performance, must be considered. If the stop-loss is set too near to the current market price, the trader may be forced to sell at a loss, while if it is set too far away from the price, the trader may be forced to risk additional money.
The trailing stop loss should be set below the current market price when going long (buying). A trailing stop-loss order for a short sale will be set higher than the current market price.
A guaranteed stop-loss order is used to ensure that a trade is closed at a predetermined price rather than the next available market price. This technique is helpful for preventing falls.
Trailing stop-loss example
Take the example of a stock purchase at £10 per share: rather than setting a stop-loss order to sell at £9, you create a trailing stop-loss order to sell at 10% below market price.
If the price drops to £9, the stock will be sold immediately because it has lost 10% of its value. In contrast, the stop-loss will increase along with the share price, never moving more than 10% below the current market price. Your trailing stop-loss would increase to £13.50 if the share price rose to £15 from its current level of £12. A total benefit of £5 is thus not yet realized. You would make a profit of £3.50 if the share price dropped to £13.50, at which point your trailing stop-loss would be activated.
How to place a trailing stop order
The distance from the market price at which your trailing stop-loss order will be placed is often determined by the amount of capital you are willing to lose on the deal. If the market advances in your favor, the stop-loss will remain at this distance from the price. As prices rise, the stop-loss will rise with them.
To mimic the effect of a trailing stop, some investors choose to manually adjust their stop-loss anytime the market price moves in their favor.
Technical indicators can be used as a further direction for trailing stop orders by some traders. Indicators like average true range (ATR) can help traders determine how much a particular instrument has fluctuated over a specified time period on a chart. This will let them know roughly how much price movement is to be anticipated throughout the trading day. However, this wouldn’t account for major unanticipated volatility like that triggered by breaking news.
The following screenshot is of the CMC Markets interface for adjusting the parameters of a trailing stop-loss order.
In conclusion, a trailing stop-loss is a free risk-management tool that can help you maximize your trading earnings while minimizing the danger of incurring a large loss. Small profits can be magnified by the use of a trailing stop, which is activated only by upward price movement. You can indicate the amount you’re willing to lose on the deal, or set a price or a percentage discount off the market price. Protect yourself from losses while locking in potential gains with a trailing stop-loss.