Strategies of working with a trailing stop in trading

What is a Trailing Stop Order?

A trailing stop loss order is the same stop-loss order, but a ‘moving’ one. This means that the trailing stop order follows the price at a set distance, which allows traders to minimize the loss and lock in the potential profit.

Risk management is the key element of trading in the financial and other markets. A wrong approach to risk management could lead to zero profit at best and the loss of investment in the worst case scenario, which is what happens most of the time. When planning a position and entering the market, every trader must have a specific plan not only for the profit, but also for the loss.

Therefore, you need to clearly determine the amount you are ready to part with in case your decision turns out to be wrong one. Based on this amount, a trader either closes an unprofitable position manually once a certain number of points is reached or sets a ‘protection’ order, i.e. the Stop-Loss order.

In the first case, traders can be more flexible about the time of closing the unprofitable position based on the situation, for example, if a plunge or a surge of the price against the trend is observed after the release of some macroeconomic data, and the price then returns to the trend and continues to grow or fall. If a trader is confident about the briefness of such a surge/plunge, he/she can decide not to close the position and thus avoid a loss.

However, there is always a probability of a trader making a mistake, and the price deviation from the trend could turn into a reversal, causing the trader much higher loss. In order to avoid that, a trader can make a firm decision to close the position at a loss not exceeding a specific amount and set a traditional Stop-Loss order at the required distance in points.

In that case, you can avoid substantial loss, but risk finding yourself in the situation that was described above. In this case, there is another option, i.e. setting a Trailing Stop Loss order. It works in the same way as the traditional Stop-Loss order, but the difference is that you can use the trailing stop order to reduce your loss, break even, or even close your position at some profit.

Everything is done automatically, i.e. the stop-loss order ‘trails’ as the price moves by a set number of points. This way, the human factor, when greed takes precedence over common sense, and the trader suffers a loss that he cannot afford and is not able to recapture is excluded. Meanwhile, when trading the trend, if a stop loss order is triggered, he/she may not only not suffer a loss, but also remain with some profit.

How do trailing stops work?

A trailing stop loss order follows favorable price movement at a set distance. Once the price moves the predetermined number of points, the order becomes active and starts ‘tracking’ the price movement. As the price moves towards the open position, the trailing stop order moves the same distance, and if the price moves against the position, the order remains at the set position and is triggered, with the trader exiting the trade either with a planned loss or some profit, if the price moved in the ‘right’ direction by more points than were set.

Trailing stop order vs Stop-loss order – pros and cons

A stop-order limits and minimizes losses, while a trailing stop order allows you to lock in the profit on the position in case of trend reversal, but only if the price moves at a larger distance than that set for the trailing stop order.

For example, if the distance from the price is set at 50 points, a trader will suffer a loss of 50 points in case of price reversal. In this case, the order is triggered as the trailing stop-loss order. If the price moved 70 points from the entry point, in case of a reversal and triggering of the order, the trader will earn a profit of 20 points. In this case, the order is triggered as the trailing stop order.

Since each of these types of trailing orders performs its own specific task, there is no sense in discussing the pros and cons of each of them.

Trading strategies using a trailing stop

Calculating a trailing stop-loss order is rather a complex task. On the one hand, a trader needs to limit his/her potential loss, but one the other hand, they have to avoid the order getting triggered during a temporary rollback. Support/resistance levels are traditionally used, with the trailing stop-loss orders set below or above them.

Setting a trailing stop-loss on moving averages

These levels are identified using various instruments, specifically moving averages, horizontal and descending resistance lines and ascending support lines, etc. In a flat and a movement in a certain direction within a clear corridor, it is also enough to also draw lines along the price lows and highs.

Example with moving averages

Trailing stop loss example using moving averages

This example is suitable for medium and long-term traders. It is a day chart with 20, 50 and 100-day MA. We can see a stable downward trend on the chart, where the price continues to decline after reaching a rollback.

Let’s assume that a short position was opened on a rollback after the breakout of the support level and crossover of the moving averages. It would be advisable to set a trailing stop-loss order over the 100-day MA, i.e. approximately 200 points from the opening price. Therefore, in case of a false breakout and trend reversal, a trader would have suffered a fixed loss of 200 points, which is generally acceptable for a long-term term trader, whose target is at least 400 points. At the same time, if the trend continues, as we can see on the example above, the size of potential loss would decrease, while later on a trader could expect a 200-point guaranteed profit in case the trailing stop order is triggered on a correctional rollback.

Using a trailing stop to trade the trend

In addition to using a trailing stop to limit your losses, you can also use it to open positions on the trend. In this example, the 50-day moving average is showing a good area of resistance levels you can use to sell. However, in this case, you will need to adjust the levels to sell in the trailing stop manually. After opening a position, a stop-loss order is placed over the 100-day MA. It will work in the same way also if you enter the market not in the very beginning, i.e. not at the reversal, but as the price moves on rebounds.

Using a trailing stop to trade the trend

In the example above, we use the descending resistance level instead of the MA. Based on the market, you need to set a trailing stop-loss order at a certain distance from the descending line.

Trailing stop example

You can use a Buy Limit Order, i.e. closing of the position, together with the trailing stop. In order to determine potential levels for closing the position, you can draw a descending support line, in the area of which the buy limit order is set.

An experienced trader can use support and resistance levels, including ‘intermediate ones’ for partial closing of the position, both at a profit or loss. This means that a stop-loss can be set for a part of the position above the 50-day MA, and for the rest of the position – above the 100-day MA. In the hope of the breakout of the descending support line and ‘vertical’ fall by a considerable distance, a buy limit order (closing) can also be set for a part of the position.

Here is another example of placing a trailing stop-loss order.

An example of placing a trailing stop-loss order

If you enter the market on the trend during a rollback, a stop-loss order can also be set above the previous high (resistance).

In case of sharp moving along the trend, you can reduce the trailing stop order distance, i.e. lock in a higher profit than previously planned. Later on, if the price rolls back in the opposite direction, you can re-open the position by placing a trailing stop-loss order based on the above principle.

Best Brokers 2024

1

9.4/10

Go to broker

eToro is a multi-asset investment platform. The value of your investments may go up or down. Your capital is at risk. Don’t invest unless you’re prepared to lose all the money you invest.

Minimum deposit:

$50

Bonus for deposit:

0%

Regulation:

CySEC, FCA, ASIC

Review

The eToro broker was founded in 2007. The company promotes itself as a social trading platform working with traders from over 140 countries. The broker has several divisions operating under different jurisdictions and licensed by different regulators. For example, eToro (Europe) is licensed by the Cypriot regulator CySEC (109/10) and eToro (UK) is licensed by the British regulator FCA (583263). The broker also has a representative office in Australia and the USA. eToro Profile Details

Pros/Cons

•the minimum transaction amount for copying is $1;

•handy functionality for passive investing;

•regulated by independent monitors;

•it is possible to purchase contracts for fractional shares (that is, to invest amounts less than the cost of one share);

•it is possible to buy shares at once (not CFDs) on the US stock exchanges.

•high spreads;

•periodic technical failures in order execution;

•lack of the most popular platforms such as MetaTrader 4 and MetaTrader 5 in Europe and the CIS;

•no access to ECN systems, orders are processed only according to the STP (straight-through processing) scheme with access to specific liquidity providers;

•there is a commission for withdrawing funds;

•impolite support staff;

•inconvenient website.

Study Review

2

9.2/10

Go to broker

Your capital is at risk.

Minimum deposit:

No minimum

Bonus for deposit:

0%

Regulation:

FSC (BVI), ASIC, IIROC, FCA, CFTC, NFA

Review

The name OANDA is an acronym for “Olsen & Associates” or “Olsen AND Associates”. It is registered in the United States and provides its clients with a wide range of financial services in most countries of the world. The company was founded in 1996 and is currently regulated in four jurisdictions. The main regulator of the broker is the UK Financial Conduct Authority (FCA). Oanda Canada is licensed by IIROC. The company has several significant awards to its credit, including a victory in the category "Best Forex Trading Technologies" from the UK Forex Awards, "Best Trading Platform" from FX Week, as well as "Best Customer Service" from the US Foreign Exchange Report.

Pros/Cons

•Minimum deposit from 1 dollar.

•A large selection of the most popular trading instruments.

•Several reliable and reputable financial regulators.

•Inconvenient and poorly functioning site.

•Lack of cent accounts.

•Lack of bonus programs.

Study Review