Are you tired of watching your hard-earned profits slip away when the market turns against you? It’s a common problem for investors and traders—prices rise, you make a profit, but when the market suddenly drops, your gains vanish.

That’s where a trailing stop order comes in. This powerful tool can help protect your profits by automatically adjusting your sell point as the price rises.

In this blog post, we’ll walk you through how trailing stop orders work, how to set them up, and how they can help you limit losses while maximizing profits.

What is a Trailing Stop Order?

A trailing stop order is a type of order type used by traders to lock in profits while limiting potential losses.

It is designed to follow the price of a stock or other asset as it rises, but it only moves in one direction—up. If the market price of a stock or option increases, the stop price (the price at which your sell order is triggered) will adjust accordingly, but if the market price falls, the stop price will stay fixed.

For example, if you set a trailing stop loss at 20 cents below the current market price, and the stock price rises by $1, your stop price will move up by $1, keeping that 20-cent buffer.

However, if the price falls, your stop price won’t adjust, and once it hits that stop price, your sell order will be triggered.

How Does a Trailing Stop Work?

To understand how a trailing stop loss functions, let’s break it down into simpler terms:

Trail Amount:

This is the amount by which you want your stop price to trail behind the market price. You can set it as a fixed amount (for example, 20 cents) or as a percentage of the market price.

Market Price:

This is the current price of the asset (e.g., a stock). As the price moves, your trailing stop will follow along, ensuring that you lock in profits if the price rises.

Stop Price:

The stop price is the trigger point for your order to sell. When the market price drops by the amount of your trailing stop, your stop price will be hit, and the order will be submitted.

For instance, if the market price falls by 20 cents and you’ve set your trailing stop at 20 cents, your sell order will be triggered, and the trade will be executed.

The key advantage of a trailing stop order is that it lets you lock in profits while still allowing for the possibility of greater profits as the market price continues to rise. It also helps limit losses by automatically selling if the price starts to fall, without you needing to monitor your position constantly.

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Trailing Stop-Loss vs. Trailing Stop-Limit

Two common variations of trailing stops are trailing stop-loss and trailing stop-loss orders. While both work similarly, they have different features:

Trailing Stop-Loss Order:

A stop-loss order is triggered when the market price falls below your stop price, and the trade is executed at the market price available at that moment. This can sometimes lead to slippage, especially in volatile markets.

Trailing Stop Limit Order:

A trailing stop limit order, on the other hand, includes a limit on the price at which the order will be executed. Once your stop price is hit, the order becomes a limit order.

This means that it will only be filled at the specified price or better. If the price moves past your limit price, the order will not be executed, which could lead to missed opportunities in some cases.

When Should You Use a Trailing Stop?

Using a trailing stop order is most effective when you want to protect profits in a rising market while also limiting your risk in case the market reverses. Here are some examples of when to use a trailing stop:

When a stock price rises steadily:

If you have a stock that has been increasing steadily, a trailing stop can help you lock in profits as the price goes up. As the market price rises, the trailing stop adjusts, protecting your gains.

When you want to limit losses:

A trailing stop is an excellent way to limit losses without needing to constantly monitor the price. Once the stop price is hit, your order is submitted, protecting you from further losses.

In volatile markets:

If the market price is moving up and down rapidly, a trailing stop allows you to continue to use a trailing stop to lock in profits while still giving your trade room to breathe.

How to Set Up a Trailing Stop Order

Setting up a trailing stop order is fairly simple, and most online brokers make it easy to enter. Here’s a step-by-step guide:

{"content":"Choose your asset: Select the stock or asset you want to trade.","meta":[],"items":[]}
{"content":"Decide on the trailing amount: You can either set a trailing stop-loss as a percentage of the market price or a fixed trail amount (such as 20 cents).","meta":[],"items":[]}
{"content":"Enter the order: Once you\u2019ve decided on your trailing stop settings, place the order to sell. Make sure you choose the correct order type (trailing stop order) and enter the trail amount in the provided field (e.g., 0.20 trailing amount).","meta":[],"items":[]}
{"content":"Monitor your position: Once your order is submitted, the trailing stop will automatically adjust the stop price as the market price rises. If the price falls by the trial amount, the stop price will be hit, and the order will be executed.","meta":[],"items":[]}

Common Mistakes to Avoid with Trailing Stops

While trailing stops are powerful tools, there are some common mistakes to be aware of:

Setting the trailing stop too tight:

If you set a trailing stop too close to the market price, small fluctuations can trigger the order prematurely. For example, setting a trailing stop amount of 0.20 might cause the order to trigger if the price falls by just a few cents.

Not adjusting for market volatility:

In volatile markets, the market price can move quickly. If your trailing stop is too narrow, it might trigger too early, locking in small profits or resulting in a sell order at unfavorable prices.

Not understanding order types:

Understanding the differences between a trailing stop-loss and a trailing stop-limit is key. Always choose the one that aligns with your risk tolerance and trading strategy.

The Benefits of Using a Trailing Stop

Using a trailing stop order has many benefits for both new and experienced traders:

Locks in profits:

As the market price rises, your trailing stop adjusts to help you lock in profits without needing to constantly monitor the market.

Limits losses:

If the price starts to fall, your trailing stop will trigger the sell trailing stop order, limiting potential losses.

Automatic execution:

Once you set a trailing stop, the order is executed automatically when the stop price is hit. This saves you time and effort, as you don’t have to manually sell.

Conclusion

A trailing stop order is an essential tool for traders looking to protect profits and limit losses.

Whether you’re new to trading or a seasoned investor, understanding how trailing stops work and how to set them up can significantly improve your trading strategy.

By choosing the right trailing stop-loss or trailing stop-limit settings and avoiding common mistakes, you can confidently manage your trades and potentially increase your returns.

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Learn Trailing Stop Orders: A Guide to Order Types