Trailing Stop Definition: Day Trading Terminology
This is a special trade order that disallows the setting of the stop-loss price as a single absolute dollar amount but allows the setting of the value as a percentage usually below the market price. The percentage value helps to track the securities price direction automatically and does not require any manual reset.
A trailing stop limit order refers to a sell trailing stop limit that moves with the market price and recalculates the stop trigger continuously at a fixed amount which is below the market price. This is usually based on a user-defined trailing amount.
On the other hand, a trailing stop loss order refers to an order that involves the buying and selling of securities when they move in an unfavorable direction. This value is automatically adjusted according to the current market price of a security. As a result, the investor or trader is provided with greater flexibility finally profiting or limiting a loss.
Significance of trailing stop
As a loss order, trailing stop can be adjusted automatically to maintain a trigger price. For this to happen, the trigger price must follow the market price in a favorable direction. For example:
i. In a long position, the trailing stop would be set below the current market price of the security
ii. In a short position, it would be set above the current market price.
So, how is this helpful?
It helps to protect gains by allowing a trade to remain open and profitable. This only happens when the price moves in the right direction and the closing trade results in price change direction as a result of a particular percentage.
Traders and investors are able to make decisions that pertain to selling easier with more rationale and less emotions. Furthermore, they are able to minimize risk while maximizing potential gains.
How it works
It is common for new traders to implement entry strategies but no exit plan. This is not surprising because new traders are known to place emphasis on entry strategies and not exit plans. For one to be successful in trading not only should their entry strategies be perfect but their exit plans too. Here is how trailing stop works.
As a trader or investor, you have bought a particular stock at the current market price of $20. To protect your principal, you opt to set an 18% trailing stop order immediately. The purpose for this action is to ensure that if the current market price of the stock declines by 18% or more, the trailing stop with be activated. This will cap your loss. If the stock price jumps to $25 in the coming months, you will get to enjoy the gains that accompany its appreciation.
Tips for setting trailing stop
a. It is wise to set a percentage value that is not too tight. It should provide room for the trading position to run
b. It is also wise not to set the trailing stop value too wide. This may result in too much money being left on the table
c. If you are a newbie trader and in doubt, consult a professional.
Trailing stop is a great tool for traders and investors who lack enough discipline to lock in gains or cut losses. It helps to eliminate emotions during trading and provide protection to the principal. To ensure success, you have to consider the percentage value very carefully.
It should not be too tight or too wide. Furthermore, you have to avoid frequent trading as this will result in more fees and commissions which will eat into your profits. To ensure success, always have a perfect entry and exit strategy.