Trailing - How and Why

Trailing - How and Why?

Many traders don't fully understand the use of a trailing stop, and consequently you may see comments from some that say a trailing stop can lose you profits. This shows a clear misunderstanding of the application of a trailing stop, which should be a positive addition to your arsenal of tools.

A trailing stop can be implemented automatically, under your direction, or you can manually trail a price, although that method is time intensive. A trailing stop on your trading system simply means that you have a moving stop loss order. It moves to trail behind the actual price. If the price comes back towards the trailing stop, it does not move backwards. If the price increases again, the stock will move along with the price, at the distance that you set.

The distance that you set the trailing stop from the price is key to its performance. If you set it too close, then minor fluctuations in the price can take you out of the trade when the trailing stop is hit, and this is what makes some traders say you lose profits from using a trailing stop. If you set the trailing stop too far away, then you may lose a substantial part of your gains when it is finally hit, even if the trade does go your way.

To find the “best” distance, you need to consider the volatility of the price, so that you minimize the chance of being stopped out when the price is still trending. Some people consider that twice the normal price range is a good distance for the stop to be from the actual price, and you should experiment in a particular market to see what works most consistently.

The trailing stop can be set on most trading systems, although some will limit the distance that it is from the price. It can usually be expressed as an absolute value, or number of pips, or as a percentage of the price. When trading in the short term, the price will not vary much, so it is fairly clear how many pips a particular percentage figure is likely to be. It's really a matter of personal preference.

The really nice thing about a trailing stop is that it will guarantee to keep your profits on a trade that starts off by going your way. Suppose after making a trade the price moves 15 pips in the anticipated direction. If you have decided that your trailing stop will be 15 pips behind the price, then at this moment your stop will be at the price you bought (ignoring the spread, for simplicity) and you will be guaranteed to get your money back.

As the price continues trending in the desired direction, the trailing stop will move with it, always 15 pips behind, and that will have the effect of locking in your profits. If and when the price starts going against you, it will only have to come down 15 pips and your trailing stop will trigger and exit the trade, to realize your profits.

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Mark Soberman of NetPicks LLC has been trading for over 20 yrs and offers free educational resources, online discussion forums, live forex and futures signal services, as well as live webinars.7 Secrets