A trailing stop order can be described as a variation of a standard stop order. It helps traders align with market trends while effectively managing their exit plans.
If you are eager to learn more about trailing stop order, and how it works, do give this article a read.
What Is A Trailing Stop Order?
To put it in simple words, a trailing stop order is used by traders to secure profits and manage their potential losses in a volatile market. This type of order is set at a specific percentage that is different from the current market value. It enables traders to lock in gains as the price fluctuates in their favor.
As the market price fluctuates, the trailing stop order adjusts accordingly, maintaining the pre-set percentage away from the current market value. This helps traders to stay in the trade and gain profit as long as the market price fluctuates in their favor.
If the market value starts moving in the opposite direction and reaches a pre-set percentage, the trailing stop order will automatically close the trade at the prevailing market price. This can help traders limit potential losses by exiting the trade when the market price becomes unfavorable.
It’s crucial to understand that the trailing stop order does not readjust if the price starts moving positively again after executing. Therefore, traders must carefully set their trailing stop order at a level that aligns with the market conditions.
Moreover, traders have the option to place trailing stop orders as reduce-only orders, which can be used to close or decrease the size of an open position. This flexibility allows traders to adapt their strategies to changing market conditions and protect their investments more effectively.
Using A Percentage As A Trailing Amount
When setting a percentage for the trailing amount, it’s essential to keep in mind that the point difference between the trigger price and the current market value will fluctuate as you recalculate the trigger price.
When implementing a sell order as a trailing amount, the gap between the trigger price and the security’s current price will increase with the rising market value. This occurs because the percentage is applied to a new, higher price, resulting in a larger point spread.
Conversely, for buy orders using a percentage as the trailing amount, the gap between the trigger price and the security’s current price will decrease as the market value drops. Since the percentage is calculated based on a new, lower price, the point difference becomes smaller.
Pros & Cons Of Trailing Stop Orders
Trailing stop orders offer valuable benefits for traders seeking risk management and profit protection. Below are the pros and cons of employing trailing stop orders.
- Automatic Adjustment
Trailing stop orders adjust the stop loss level as the current market price changes in favor of the trader. This feature allows traders to lock in gains while allowing room for more profits.
- Effective Risk Management
By setting an automatic stop loss level, trailing stop orders help limit potential losses. It is helpful in effective risk management during volatile market conditions.
One of the good things about trailing stop orders is that they can be customized to specific dollar amounts or percentages. This allows traders to adjust their stop loss levels to align with their trading strategies.
- Hands-Off Approach
Traders can step away from the market with confidence, as trailing stop orders ensure protect against adverse price movements.
- Market Gaps
Trailing stop orders may fail to protect against abrupt price changes or market gaps, potentially leading to execution or slippage at unfavorable prices.
- Execution Delays
In fast-moving markets, trailing stop orders might experience execution delays, resulting in execution or slippage at prices different from the intended ones.
Executing trailing stop orders can be difficult. It requires traders to consider both the percentage and distance of the trailing stop.
Overusing trailing stop orders without actively monitoring the market can lead to unexpected losses. This happens when traders neglect to respond to changing conditions.
While trailing stop orders can be a valuable risk management and profit-locking tool, traders must remain mindful of these potential risks. It is essential to track the market and modify the trailing stop orders as necessary to align with their overall trading strategy.
Trailing Stop Order vs. Market Stop Order
When comparing a trailing stop order with a market stop order, the primary distinction lies in their behaviors. A trailing stop order adjusts the stop loss level as the current market price moves in the desired direction. On the other hand, a market stop order is executed when the market price reaches a predetermined specific level.
Trailing stop orders are designed to enable traders to secure profits as the market price moves in their favor while making additional gains. In contrast, market stop orders limit potential losses by promptly exiting the position once the market price reaches a pre-set threshold.
As a trader, it is crucial to understand the difference between the two strategies. This will help you to execute them correctly.
Trailing stop orders serves as a valuable tool for traders who seek to control losses while securing additional profits in volatile markets. It is crucial to understand that trailing stop orders do not ensure guaranteed profits, and they may experience slippage when market prices change swiftly. It is essential to thoroughly assess the associated pros and cons before incorporating this strategy into your trading approach.