What is the Trailing Stop Loss Order?
The term trailing stop-loss is one that you’ll hear a lot in the forex and CFD trading realm, it can also be known as a trailing stop order.
Yet it may not be clear what a trailing stop loss does and why it’s important for traders. It’s one of the small tools that can make a lot of difference to profits.
In this post we’ll explain exactly what it is and how you can make use of a stop loss as a trading strategy.
Read on to learn how you can benefit from it.
What is a Trailing Stop loss with Example?
The best way to think of a trailing stop loss is that it’s a special kind of stop-loss order.
It’s a parameter added to a sell or buy trade. Using a stop loss can help to limit your loss on each placed position.
What’s different with a trailing stop-loss compared to a normal stop loss order is that a trailing stop will move when a price moves.
Besides this it also does other two things:
- Can help you to lock in profits on a specific trade
- Also caps the amount that would be a lost on a failing trade
This is why they’re known in the industry as profit protecting stops, because they blend elements of trade/risk management to help traders protect their profits.
A trailing stop loss can be easily set up manually when you place a trade, or automatically with many brokers or trading software.
How Does a Trailing Stop Loss Order Work?
So now you know that a trailing stop loss order will follow an order’s price movement.
Let’s see an example:
We buy on the asset EUR/USD at the price of 1.10000.
We set a stop loss at 1.09000 (so at 100 pips). Once that is done we set the trailing stop loss at 50 pips. This will follow the EUR/USD price only if it is going up.
For instance, if the price goes up, the stop will follow it, but should the price stop increasing, then the trailing-stop price won’t move. Instead it’ll remain at the last level it was carried to.
Let’s now imagine the price went to 1.11000 (+100 pips), the trailing stop loss is at 1.10500 (50 pips distance).
At this point the price drops and goes down. Our trailing stop loss won’t move from his position, and once touched by the real price will close the order saving a 50 pips profit.
By using a trailing stop loss you can make the most out of trades by locking in any profits if the price moves in your favour, whilst protecting yourself against greater losses.
Depending on the platform you are using, the trailing stop loss can be set from 5 to 100 pips distance, and usually it is supported by professional platforms like MT4 and MT5.
Placing Trailing Stop Loss Orders
These days many brokers will offer some type of trailing stop loss order. The most common platform where to use it is the MT4.
Let’s see how to place it:
- Choose an asset to trade
- Open your trade with a generic stop loss and take profit
- Click on the stop loss line on the chart with the right button of you mouse
- On the window it will open select „trailing stop loss“
- Choose the pips of distance you desire
- Confirm the modification
The stop loss will start to move once the price will grow more that then selected amount of pips and will follow the trend.
Positives and Negatives of Trailing Stop Loss Orders
Using a trailing stop-loss is a great choice for traders who many not be disciplined enough to cut losses or wait for profits to be locked in. That’s because it helps to remove some of the human emotion from the whole trading process and offers automatic capital protection.
Generally a stop loss is there because it can help you to exit a trade if there’s a high chance of the price decreasing and erasing any profits.
Like any tool though, there are also some downsides to using a trailing stop that you should consider. One important one is to always think very carefully about the trailing stop amount/percentage.
Ideally a trailing stop should be set at a distance from an existing price that you don’t think will be reached, not unless there’s volatility and the market changes direction.
Otherwise if you place a trade in a volatile asset with the wrong percentage, it could be that the stop level would be triggered quite often.
Another drawback can be that occasionally the tool may get you out of a trade prematurely. This could happen if an asset’s price is not reversing but just being pulled back a little.
What is the difference between trailing stop loss and trailing stop limit?
A trailing stop loss is an order you place on your trade, which makes your stop loss order move by the selected amount of pips.
A trailing stop limit is an order you place on your stop loss, and stops the platform to close the position too soon and for a too low price. It moves the stop loss until a certain price you have selected.
Let’s see an example: you have bought Amazon shares at $100 with a stop loss at $80. For this position you have also placed a trailing stop limit at $70. This is means at $10 from the stop loss order.
In case of volatile market, the price of Amazon drops to $71. In this case, thanks to the stop limit the position won’t be closed in loss, because the price didn’t go below $70 (where you have you trailing stop limit).
This helps to stay in the market and wait for it to swing back and potentially make a deposit.
In this example it’s clearer how the trailing-stop limit works: it prevents the platform to close the order too soon by keeping the position open until the stop limit price.
This means the only situation where the stop loss would have closed you order is when the price is below your trailing stop limit prices.
When to use a trailing stop limit
It is good to use a trailing stop limit only in situations where there is high volatility in the market. In this case it’s very common to see prices going up and down by many pips or dollars.
With a normal stop loss order, or even a normal trailing-stop-loss, your order would be closed immediately, causing a potential loss in profits.
With the stop limit you can stay in the market and benefit from it when it bounces back.
For normal market situations, so when there is low volatility and the trend is regular, using this order wouldn’t be suggested.
The reason is that there won’t be moment where the price drops and in few minutes swings back again.
For instance, if you have bought some Amazon shares on a normal market situation, and the price starts to drop, it will probably keep on decreasing by many dollars. Then having a standard stop-loss, without any limit, is the wisest choice. It can easily stop you losses at a certain price, preventing you from losing much more money.
Finally, it is very important to mention that this order is available only for stock trading. You can’t set it up for currency trading, indexes, cryptocurrencies or commodities trading. Every platform offers it in its tools.
You can set it up going to the edit dashboard of you stock broker. There isn’t a limit on number of times and price you can use it. You can also use it for every stock you want.
Should you use Trailing Stop Loss?
Using a trailing-stop-loss is a good strategy to use when trading if you feel confident enough for it. Generally this technique is used by more experienced traders who can predict how many pips of volatility there will be in the market.
The fact to setup a movable stop loss can be dangerous in very volatile markets. This is because during high volatility the price of an asset can increase and decrease by more than 30 or 40 pips in few minutes. Using a trailing-stop-loss with a range of 30 pips could close the position too soon if the prices grows, goes down of few pips for then drastically grow again.
When selecting the amount of pips you want your trailing stop, you have a set range given by the platform, which goes from 10, 20, 30, 50, 100, up to 150 pips. If you want, there is also the possibility to make a custom selection and choose any number of pips you like.
This is why the recommendation is to use it only if you have some experience in trading and you can read an economic calendar and know if a market can be very volatile on that day.
Finally, the main benefit of a trailing-stop-loss is that you can “lock” some profits which has already been made if the market moves to the right direction. This is a great strategy which helps to avoid situations where the price of an asset grows and suddenly drops, going from a profitable situation to a loss.
Author of this article and founder of Tradingonlineguide.com
My aim is to help you increase your trading knowledge with helpful content. I come from an economic background and have a strong passion for forex trading. With more than 6 years in the online trading world, I want to share my financial knowledge so that anyone can develop their investment skills.
In my spare time I enjoy cooking and travelling.
Here you can learn more about our review methodology.