Trailing Stop Loss Explained for Beginners

Learn how to make use of a trailing stop loss order when trading online right here at StockWire with our expert guide. We’ve compiled another informative piece on this dynamic order type for trading in 2023 online with the best trading sites. 

What’s the Meaning of Trailing Stop Loss?

Trailing stops are variations on the standard stop order used by investors. A trailing stop can be implemented by identifying a dollar amount or even a percentage change away from the market price and setting a trailing stop equal to this amount. 

Trailing stops have the added advantage of enabling traders to keep their positions open as long as the price movement is going in the right direction. The position will only be closed by the trailing stop order if the price change moves in the opposite direction by the set amount or percentage. This order type can be set in conjunction with the trade or after the fact. 

• Long position: Trailing stop loss is set at an amount below the market price. 
• Short position: Trailing stop loss is set above the market price of the security in question. 

The Reason for Using Trailing Stop Loss Orders 

Trailing stop loss orders can be used when trading standard stocks, futures, and options. The reason why a stop loss is used is because it enables traders to achieve a desired result more successfully. Combining a stop-loss with a trailing stop, trade orders will revise the price where the stop-loss price ends up. Standard stop-loss orders are fixed while the dynamic nature of a trailing stop means that the amount below the market price changes as long as the price increases. 

Know How a Trailing Stop Works 

The security that has a trailing stop will ‘pull’ the trailing stop up with it if the price happens to increase. If the price then plateaus, the trailing stop loss point will be at the price level that it was pulled up to. This ensures profits for an investor beyond the initial price increase and protects the downside. 

Bear in mind that a trailing stop doesn’t move in two directions. Rather, it moves in one price direction which enables an investor to mitigate losses or ensure profits. For example, a 20% trailing stop loss which is used on a long position will issue a sell trade if the price decreases by 20% from the highest price point. If a trailing stop moves up, it won’t move down again. 

As mentioned, trailing stops can be used across instruments as long as the online trading platform in question offers the service. It’s also possible to enact trailing stops as market orders or more specifically, limit orders. 

Implementing Your Own Trailing Stop Order

If you are interested in using a trailing stop, then it’s imperative that you don’t set the monetary or percentage level too wide or too tight. 

Too tight: Trailing stops set to tight will be very sensitive to price movements which occur on a daily basis. If set too tight, then the stop-loss will trigger without any movement in favor of the trader. Subsequently, this will most likely lead to a loss. 

Too wide: If a trailing stop is set too wide, then it’s possible to accrue very large losses while also missing out on substantial gains. 

The entire concept behind using a trailing stop is to make sure profits are secured and losses mitigated as much as possible. However, knowing at exactly what point to set a trailing loss is not so easy. There isn’t any foolproof point at which it should be set because market and underlying assets move differently across the board. But, it has proven to be a popular trading tool that enables traders to exit trades by fulfilling its function: limiting losses and ensuring a profit. 

Top Tip For Utilizing Trailing Stops While Trading

There certainly is a trading psychology which you can utilize so that you make the most of trailing stop orders. When the price of a stock drops temporarily, many individuals will look to reset a trailing stop. It’s vital that you avoid falling into this trap because your stop-loss might well level out at a price lower than what you expected. In the same breath, you should try to curb your stop loss if ever price increases seem to be hitting a climax. 

Knowing when to exit your positions does depend on the type of trader that you are. If you are conservative, then have a precise point at which you exit your position by applying for a sell order. If, however, you are less risk-averse, the margin of profitability and losses can be bigger and a more flexible approach adopted.