Trailing stop loss order
A trailing stop loss order is similar to a standard stop loss, but in this case the position of the stop loss is also moved as the trade progresses.
It allows you to limit the amount of money you could lose if a trade moves against you. It can also help you gradually lock in profit as a trade moves in your favour.
In theory, the market could move infinitely in the direction of your trade, giving you the potential to make a huge profit with a strictly limited risk.
Trailing stop losses are most effective in trending markets, where prices are moving steadily in one direction.
Different kinds of trailing stop loss orders
There are two types of trailing stop loss orders that you can use: an automatic trailing stop loss or a manual trailing stop loss.
Automatic trailing stop loss
An automatic trailing stop loss automatically adjusts its position as the price of an asset moves in your favour.
A benefit of a trailing stop is that it enables you to walk away from an open trade, leaving the automatic trailing stop loss to manage it for you.
Pre-set the amount of pips to trail your position
With this type of stop loss, you pre-set its parameters so that for every "x" number of pips that the price moves in the direction of your trade, the trading platform moves the stop loss "x" number of pips closer to the current price.
For example, you could enter the market with a long, or buy, position and set a trailing stop loss 30 pips below your entry price. This means that if the price drops 30 pips below your starting point, the asset will be sold, the trade will be closed and your loss has been limited to 30 pips.
If the trade goes in your favour, for every pip that the price rises by, your stop loss will automatically move one pip higher too, helping you limit the loss and eventually lock in profit as the trade progresses.
Note that a trailing stop only moves in the direction of your trade. If the price moves against your trade, the trailing stop stays still.
The image below shows an example of how the entry point and the subsequent movement of the stop loss positions could appear on a chart:
- Long entry
- Initial stop loss is placed 30 pips away
- As the price moves in favour of the trade, the stop loss continually trails 30 pips behind.
- Stop loss continues to move up 30 pips from the current price
As shown above, the stop loss remains 30 pips away from the current price throughout the trade. This means that if the market continues to rise, the trade will carry on locking in profit until the price eventually reverses or you exit the trade.
Note that in the chart above, the stop loss would be continually moving upwards every pip as the price moves up every pip. We have just shown you two points where the stop loss would be behind the price to demonstrate that the stop loss moves.
Changing the stop loss order settings
You can change the settings for automatic trailing stop losses – for example how far above or below your entry point you want to place them and how often they will move behind the price – according to your preferences.
For example, you may want to set the trailing stop loss behind the entry by 10 pips and then only get the stop loss to move when the price goes in your favour by 5 pips, in which case the stop loss would then move up at this point to 5 pips behind the entry.
There are also computer programs that can use other methods of automatically trailing a stop loss. For example, MetaTrader 4 allows you to program robots that would trail your stop behind a moving average.
Manual trailing stop loss
A manual trailing stop loss follows the same principle as an automated trailing stop loss but you manually adjust its position, rather than relying on a computer programme to move it a pre-determined number of pips.
There are a wide variety of technical indicators and price action methods that will help you decide where to position your manual trailing stop loss and when to adjust it.
Using the Parabolic SAR
One of the most popular technical indicators that traders use to position their manual trailing stop losses is the parabolic SAR indicator. This indicator helps you determine when the price of an asset will change direction or reverse its trend.
The idea is to adjust the stop loss each time the SAR moves closer to the entry price until eventually profit is locked in. The trade is closed when the price eventually reverses. This means that in a long trade, the stop loss is always just below the most recent SAR as the price moves up in favour of the trade.
The image below demonstrates how this looks on a chart as the price moves in the favour of a long trade:
- Long position
- Initial stop loss below the most recent SAR point
- Stop loss is moved manually as each point appears
- Stop loss continues to move up under the next SAR point
- Stop loss continues to move up under the next SAR point
Note that in the chart above, you would move the stop loss each time a SAR point appears, we have shown you a few select examples as the trade moves up to show you how the stop loss would move under the SAR.
Swing highs and lows for stop losses
Indicators are a good way to start using trailing stops. However, once you gain more experience, you can use price action.
One of the most common ways to manage a trailing stop loss is to use the most recent swing lows or highs.
The key feature of this is that the stop loss is not a fixed amount away from the current price, but rather based on the price levels.
The chart below shows how a trader uses the most recent swing highs to place stop losses in a short trade:
- Short entry
- Initial stop loss above recent swing high
- Stop loss is moved down to the next swing high
Using different indicators and methods
There are many other indicators and methods that can be used for a trailing stop, such as:
- moving averages
- trend lines
Trailing stop losses in ranging markets
Trailing stop losses are less effective in ranging or choppy markets as trades can be stopped out (automatically exited) prematurely when prices move erratically. This means that even if prices do eventually move in the direction of your trade, you may have lost the opportunity of profiting from this or it may take several entries to eventually catch the trend.
- Long position
- Initial stop loss 20 pips below the entry level
- Stop loss moved up to be 20 pips below the current price
- Trade stopped out as the market ranges
- Market eventually moves in the direction of the trade, but the trade is stopped out before.
In this lesson, you have learned:
- a trailing stop loss order is similar to a standard stop loss but in this case the position of the stop loss is also moved as the trade progresses.
- it allows you to limit the amount of money you could lose if a trade moves against you, but also helps you gradually lock in profit as a trade moves in your favour.
- it enables you to walk away from an open trade – in theory the market could move infinitely in the direction of your trade giving you a huge profit potential with limited risk.
- an automatic trailing stop loss order automatically adjusts its position as the price of an asset moves in your favour.
- a manual trailing stop loss order follows the same principle as an automated trailing stop loss but you manually adjust its position as the price moves.
- technical indicators and price action will help you decide where to position a manual trailing stop loss and when to adjust it.
- the Parabolic SAR – an indicator that helps you identify price reversals – is one popular choice. You can also use a moving average, trend lines and channels.
- you can also use swing highs and lows to trail your stop loss.
- trailing stop losses are less effective in ranging or choppy markets as trades can be stopped out prematurely, meaning you cannot profit if prices do eventually move in your favour.
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