Trading without solid risk management is like jumping out of an airplane without a parachute. One of the foundational tools for protecting your trades is the stop order. A refined version of this is the trailing stop order, often just called a trailing stop.
This guide will explore in detail how trailing stops work, including variations like the trailing stop loss, trailing stop limit, and trailing stop buy. We'll also look at additional stop tools available in advanced trading platforms and how to use them correctly.
What Is a Trailing Stop?
A trailing stop is a type of order where a trader sets a specific price level. If the price of an asset reaches this level (or breaks through it), it automatically triggers a trade order. This price level is often called the trigger price. Once hit, the stop order immediately converts to a market order (buy or sell) and is executed at the best available price.
A trailing stop loss—the most common type—is a special trade order where the stop price isn't fixed at one value. Instead, it moves along with market fluctuations.
So, what makes this dynamic or "trailing" order special?
The core idea is to maximize profit potential when the market moves in the expected direction while locking in the best possible gains if the trend reverses. In other words, a trailing stop lets your winners run and minimizes the give-back of profits during a counter-move.
Trailing Stop Example
Suppose you buy a stock from Company X at €10. Your strategy is to risk no more than 5% of your investment. You set a trailing stop at 5% below the current market price. If the stop level is hit, an automatic sell order is triggered. But if the market price rises, the trailing stop follows it upward ("to trail" means to follow). The stop loss remains at the level it was dragged to, even if the price stops rising.
In practice, a trailing stop is an excellent way not only to prevent losses below the original fixed stop loss but also to protect profits already made.
Types of Trailing Stop Orders
To understand the different forms of trailing stops, it's important to distinguish between market and limit orders.
A market order is executed at the prevailing market rate. Although the time between order placement and execution is usually a fraction of a second, if the market is highly volatile (or "gaps"), the execution price might end up farther from your chosen stop price than you'd like.
To avoid this, there's the limit order. This order isn't executed at just any available price but only if pre-set boundaries are met.
For example, a buy limit order will only execute if the price hasn't risen above value X beyond the stop price. A sell limit order will only execute if the price hasn't fallen below value Y under the stop price.
Trailing Stop Limit
Applied to trailing stops, the distinction between market and limit orders means the following: The uncertainty about what price you'll get with a stop order (which becomes a market order once the stop price is hit) can be managed with a stop-limit order.
The limit prevents the execution price from deviating too much from the stop price. This requires defining two price targets:
- The actual stop price, or trigger price, which activates a limit order when reached.
- The corresponding limit itself.
And you guessed it: a trailing stop limit moves. This brings us to trailing stop loss and trailing stop buy.
Trailing Stop Buy
A trailing stop buy order makes sense when you anticipate falling prices and want to buy at the best possible price.
The trick is to define a trailing stop above the current price alongside the stop threshold. This can be set as an absolute value (e.g., two euros) or a percentage. The trailing stop only follows the falling price. With rising prices, it remains at the stop buy threshold, simultaneously acting as the limit.
So, a trailing stop buy essentially says: "Buy if the price is below the stop buy threshold, but only if the purchase price is at least two euros above the last low."
In practice, this means the buy order is only executed when the price rises again and hits the trailing stop.
Trailing Stop Loss
The trailing stop loss is the mirror image of the trailing stop buy.
With rising prices, the stop price is trailed upward. If the price falls, it stays at its last level. The mechanisms are analogous to those described in the previous section.
Assume the trailing stop is set two euros below the current price. If prices rise, the trailing stop rises with them, securing profits.
At the same time, should the market turn and prices fall, excessive losses are avoided by the trailing stop loss.
Pros and Cons of Trailing Stop Orders
A trailing stop can be good for investors who may lack the discipline to take profits or cut losses. The automation of the trailing stop removes some emotion from the trading process, offering a degree of capital protection.
The downside, however, is that the automation often disconnects the trader from specific market conditions. The unique aspects of each market situation aren't necessarily addressed effectively.
Other points must be considered. First, you must choose your trailing stop percentage or absolute amount very carefully. If you're trading a highly volatile asset, you'll quickly find the stop level is triggered quite frequently.
And this is a situation you'd like to avoid. Excessive trading can lead to high broker fees and commissions, which eat into your profits, not to mention potential tax implications.
When answering how to set a trailing stop correctly, two aspects must be distinguished: the technical-practical and the strategic.
The technical aspect refers to how you input a specific trailing stop point into your trade order. In practice, this means how you implement it in your trading platform.
How to Set a Trailing Stop
The simplest way to set a trailing stop in many advanced platforms is through a dedicated terminal window. The general process involves:
- Opening the terminal window from the platform's navigator.
- Confirming any necessary permissions for the terminal to function.
- Locating the T/S (Trailing Stop) field within the terminal window.
- Entering the desired trailing stop value in pips.
A pip (percentage in point) in forex trading is the smallest unit of price change, typically referring to the fourth decimal place.
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Many platforms also offer built-in calculators to help determine the appropriate stop level based on a percentage of your account equity.
Trailing Stop Strategies
If you want to work with trailing stops, you need a reference framework. This means decision-making aids to answer upcoming questions about market expectations, trading goals, and suitable instruments.
When people talk about a trailing stop strategy, it's more accurate to see it as part of the overall strategy. The trailing stop is a tactic that helps you implement your strategy.
There are many possible decision-making aids traders have developed over time for use with trailing stops.
One common tool is the Average True Range (ATR).
The ATR is a volatility indicator that shows how much an asset typically moves during a specific timeframe.
This indicator can help day traders determine the right entry point or be used to refine stop loss placement.
The ATR indicator moves up and down as an asset's price swings become larger or smaller. A new ATR value is determined for each chosen period.
The basic idea is this: At the time of a trade, you look at the current ATR curve. A rule of thumb is to multiply the ATR by two to determine a reasonable stop loss point.
If you go long (open an order expecting the underlying asset's price to rise), you could place a stop loss at 2 x ATR below the entry price. If you go short, you would place a stop loss at 2 x ATR above the entry price.
Other Order Types Beyond the Trailing Stop
Although the trailing stop is one of the most important and commonly used order types, advanced trading platforms offer several other ways to automate order triggers. These include:
Time Stop
A normal stop loss remains in the chart until manually canceled or executed. The time-based stop allows you to define a fixed stop time, for example, 5:30 PM (Xetra close in Germany). If the stop loss hasn't been executed by the market by that time, the stop loss order is automatically activated by the system, and the position is closed at that fixed time.
Stops with Active Chart Lines
Some platforms allow you to draw horizontal, vertical, or diagonal (free) trendlines on the chart. These lines can then be used as stop loss or take profit levels to limit losses and set profit-taking targets. Some tools even allow for partial closures, e.g., closing only 50% of your open order volume.
Automatic Order Closure
Beyond basic terminals, some advanced tools allow you to set automatic rules for placing and calculating stop loss, which are then applied to your orders. Once the rule's conditions are met, the set action is triggered. This could involve moving the stop loss by X points upon reaching a certain profit, activating the trailing stop, or performing a partial close.
Alarm Manager
Another tool is an alarm manager, which allows comprehensive position and alarm management based on various selectable conditions. It's possible to close positions based on price breakouts, technical indicators, economic news, and much more, either immediately or in a time-based manner. This tool can manage multiple positions at once and act as a multi-stop-loss.
Frequently Asked Questions
What is the main purpose of a trailing stop?
The primary purpose of a trailing stop is to protect profits by automatically adjusting the stop-loss level as the market price moves in a favorable direction. It allows traders to lock in gains while giving a position room to grow, effectively managing risk dynamically.
How do I determine the right distance for my trailing stop?
A common method is to use a volatility-based indicator like the Average True Range (ATR). Multiplying the ATR value by a factor (often 1.5x to 2x) and setting that as the distance from the price can provide a buffer against normal market noise while protecting your capital.
Can a trailing stop guarantee I won't lose money?
No, a trailing stop is a risk management tool, not a guarantee. It helps limit losses and protect profits, but sudden market gaps or extreme volatility can cause the order to execute at a less favorable price than anticipated. It is a crucial part of a disciplined strategy but does not eliminate risk entirely.
Is a trailing stop suitable for all trading styles?
Trailing stops are highly versatile and can be adapted for various styles like day trading, swing trading, and long-term investing. However, the specific parameters (e.g., the trailing distance) should be adjusted according to the asset's volatility and the trader's time horizon and risk tolerance.
What's the difference between a trailing stop and a fixed stop-loss?
A fixed stop-loss remains at a specific, unchanging price level once set. A trailing stop, conversely, automatically moves in the direction of a favorable price trend. It is dynamic, whereas a fixed stop is static, making the trailing stop more effective at capturing extended trends.
Should I use a trailing stop for every trade?
While trailing stops are a powerful tool, they are not mandatory for every trade. Their use depends on your strategy. For very short-term trades or in extremely choppy markets, a fixed stop might sometimes be more appropriate. Evaluate the market context for each trade.
Should I Use a Trailing Stop?
Absolutely. The truth is, trading involves a degree of guesswork. No one, not even the greatest trading legend, has a perfect crystal ball and can predict the future with certainty. So, it's part of trading to be right sometimes and wrong sometimes. You can't do anything about that.
However, you can influence how much money you can win when you're right and how much you lose when you're wrong. The instrument of choice for influencing your trading results is the trailing stop. If the trailing stop is set correctly and you've chosen an "intelligent" entry level, you put yourself in a position to let profits run and limit losses.
That is ultimately what the trailing stop is all about. Even though it will happen that you get stopped out despite a well-chosen trailing stop and the market subsequently moves in the expected direction, you will find over time that the advantages of this order method far outweigh the disadvantages. It's no wonder every trading professional has the trailing stop readily available in their toolbox!
Before you start using the trailing stop in live trading, we recommend testing its use first in a risk-free but realistic market environment. 👉 Practice using a trailing stop in a demo environment