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 in your trades.
Read on to learn how you can benefit from it.
What is a Trailing Stop-loss?
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 Work?
So now you know that a trailing stop-loss 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 a Trailing Stop Loss Order
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 a Trailing Stop Loss Order
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.