Trailing Stops are a kind of a stop loss order that throws the elements of risk management and trade management in one mix when you are trading on an Online Trading Platform. They help you secure your gains on a trade while also capping the losses if your trade goes against you.
How Trailing Stops Work
You will find most user reviews like HQBroker Review saying that when you use a trailing stop, you first place it in the same way that you place a regular stop loss order.
For instance, you’re going to place a trailing stop for a long trade, and that stop is a sell order. You would place that at a price below the trade entry. The main distinction between a regular stop loss and a trailing stop is this: the trailing stop moves as the prices move.
Say, for every five cents that the price moves, your trailing stop would also march forward five cents. Trailing stops move in the direction of the trade. Now, you’re going long, and the price moves 5 cents upwards. The trailing stop will also move up 10 cents.
Here’s the catch: the stop loss wouldn’t slide down even if the price moves.
It’s also the same for a short trade, only we expect the price to plummet down. In this case, you have to place your trailing stop above the entry price.
When Trailing Stops Don’t Work
Among traders who are using trailing stops usually fall for a mistake: they place a trailing stop too close to the current price.
For instance, they place a one or two cent trailing stop loss. Many stock prices always move up and down. They always oscillate. And that happens every minute for couple of cents. Looking at the bigger picture, if you place your trailing stop to close to the current price, your trade will be stopped out even before making any meaningful earnings.
Here’s the trick: you have to put your trailing stop at a level that you don’t expect to reach except when the market changes direction. To illustrate: suppose the market usually fluctuates within a 10-cent range, though it’s still moving in the same overall trending direction. You will need a trailing stop that’s larger than 10 cents. But don’t make it too large that the trailing stop order is useless.
Rule of thumb: the trailing stop loss should grab you and get you out of the trade when there is a big possibility of price reversal on your trade (which means your profit will be gone completely).
Now, here’s another blemish on trailing stops: it sometimes gets us out of a trade at an unfavorable time, which is usually when the price isn’t really doing a complete 360, only adjusting a bit. In this case, you can instead use a profit target order.
Trailing stops are useful tools for you to secure your trades. Whenever possible, scrutinize the trade first before deciding which stop order to use. There are many other tools like this that you can use, and we’ll discuss them further in the future. For now, try to gain more experience in day trading so that you can have a better understanding of how these tools work.