Trailing stops can be set up to work automatically with most brokers and trading systems or can be manually monitored and changed by the trader.
How a Trailing Stop Loss Works
A trailing stop-loss order is initially placed in the same manner as a regular stop-loss order. For example, a trailing stop for a long trade (selling an asset you have) would be a sell order and would be placed at a price below the trade entry point. The main difference between a regular stop loss and a trailing stop loss is that the trailing one moves whenever the price moves in your favor. For example, for every five cents that the price moves up, the trailing stop would also move up five cents. If the price were to move up 10 cents, the stop loss would also move up 10 cents. But if the price were to start to fall, the stop loss wouldn’t move. Suppose you were to enter a long trade at $40, with a 10-cent trailing stop at $39.90. If the price then were to move up to $40.10, the trailing stop would move to $40. At $40.20, the trailing stop would move to $40.10. If the price then were to move back down to $40.15, the trailing stop would stay at $40.10. If the price were to continue down and reache $40.10, the trailing stop-loss order would be converted to a market order, and you would be able to exit the trade at about $40.10, having protected about 10 cents of profit per share. If the price instead were to drop to $19.80, the stop loss would drop to $19.90. If the price were to rise to $19.85, the stop loss would stay where it is. If the price were to fall to $19.70, the stop loss would fall to $19.80. If the price were to rise to $19.80 or higher, your order will be converted to a market order, and you would exit the trade with a gain of about 20 cents per share. For example, a market that usually fluctuates within a 10-cent range while it is still moving in the same overall trending direction would need a trailing stop that is larger than 10 cents—but not so large that the entire point of the trailing stop would be negated. Another criticism is that trailing stops don’t protect you from major market moves that are greater than your stop placement. If you set up a stop to prevent a 5% loss but the market suddenly moves against you by 20%, the stop doesn’t help you because there won’t have been a chance for your stop to have been triggered and your market order to have been filled near the 5% loss point.
How to Place or Move a Stop Loss
Most brokers provide a trailing stop-loss order option. Determine how much room you want to give the trade, such as 10 to 20 cents, and double-check your order. Your stop loss should now move automatically as the price moves. Traders can also trail their stop loss manually. They simply change the price of their stop loss as the price moves.
Alternatives to Trailing Stop Losses
The main alternative to a trailing stop-loss order is the trailing stop limit order. It differs only in that once the stop price is reached, the trade is executed at the limit price you have set—or a better price—rather than at the then-available market price.
