As a trader, you may have heard the term “trailing stop order” before. This type of order is a popular tool among traders that can help them limit their losses or lock in profits. In this article, we’ll explore what a trailing stop order is and how it works.
What is a Trailing Stop Order?
A trailing stop order is a type of order that is placed by a trader to limit their potential loss or lock in profits on a trade. It is designed to automatically adjust the stop loss order as the market moves in the trader’s favor. This means that if the market moves up, the stop loss order will also move up, but if the market moves down, the stop loss order will remain the same.
The trailing stop order is a powerful tool for traders because it allows them to protect their profits while still allowing the market to move in their favor. This is especially useful in volatile markets where prices can fluctuate rapidly.
How does a Trailing Stop Order work?
To understand how a trailing stop order works, let’s consider an example. Let’s say you own a stock that is currently trading at $50 per share. You believe that the stock will continue to rise, but you want to protect your investment in case the stock price falls.
You decide to place a trailing stop order with a 10% trailing stop value. This means that if the stock price falls 10% from its highest point, the order will be triggered, and the stock will be sold. As the stock price rises, the stop-loss price will also rise. For example, if the stock price rises to $55 per share, the stop-loss price will also rise to $49.50 per share (10% below the high of $55).
If the stock price continues to rise to $60 per share, the stop-loss price will also rise to $54 per share. However, if the stock price falls to $54 per share, the stop-loss price will be triggered, and the stock will be sold.
Why use a Trailing Stop Order?
There are several reasons why traders use trailing stop orders:
- Limit potential losses: Trailing stop orders can help traders limit their potential losses by automatically adjusting the stop loss order as the market moves in their favor.
- Lock in profits: Trailing stop orders can also help traders lock in profits by automatically adjusting the stop loss order as the market moves in their favor.
- Flexibility: Trailing stop orders offer traders flexibility by allowing them to adjust the stop loss order based on their individual risk tolerance and market conditions.
- Time-saving: Trailing stop orders can save traders time by automatically adjusting the stop loss order, freeing them from constantly monitoring the market.
Trailing Stop Orders FAQs
Trailing stop orders can be used for a variety of financial instruments, including stocks, options, forex, and futures.
Yes, traders can adjust the trailing amount in a trailing stop order based on their individual risk tolerance and market conditions.
Yes, traders can set a trailing stop order for both long and short positions.
If the market price of a security gaps down and falls below the stop-loss price, the trailing stop order will be triggered, and the security will be sold.
Typically, no. This will depend on the individual broker but I’ve never heard of a broker that charges to use a trailing stop order.
Conclusion
In conclusion, a trailing stop order is a powerful tool that traders can use to limit their potential losses or lock in profits on a trade. It offers flexibility, time-saving, and peace of mind, knowing that their position is protected while still allowing the market to move in their favor. Whether you’re trading stocks, forex, or commodities, a trailing stop order can be a valuable addition to your trading strategy.
However, it’s important to remember that a trailing stop order is not foolproof, and there is always the risk of losing money in the market. It’s crucial to set the trailing amount based on your individual risk tolerance and market conditions, and to always monitor the market to ensure that the trailing stop order is working as intended.
Overall, if used correctly, a trailing stop order can be an essential tool in a trader’s toolbox, helping them to manage their risk and maximize their profits.
