How does a Trailing Stop order work?

Trailing Stops are set when traders choose the use of crossovers to pinpoint a good price or as a buy or sell signal.

This term comes after when a trader or an investor encounters a very difficult decision when it comes to cutting losses and making profits. This is where trailing stop comes in. In most case scenarios, investors usually react at the face of an incoming loss by selling prematurely as a stock rallies while other investors hold onto their shares despite plummeting prices.

Basically, these are instances when traders fail to sell their shares at the right time and price which will give them the most returns. This is a common but simple mistake that others have found to be specifically difficult to fix. This is where the trailing stop comes in.

Basics of a Trailing Stop

A trade can gain a higher value as the market price moves in an upward direction but can close in the instant the markets move into the downside with the help of a trailing stop. This will prevent any unnecessary losses and will mostly allow the trader to keep the gains they were able to get prior to the sudden drop in the market price of the stock.

Compared to fixed stop loss, the trailing stop gives a trader more flexibility since it will stop the stock from trading further once it hits a specific price point or when the market price suddenly moves down. The fixed stop loss also needs to be manually set, unlike the trailing stop which automatically reacts into a sudden turn in the market price. The trailing stop-loss order, on the other hand, is a mix of both the stop loss and trailing stop concepts without the limitation of stop-loss orders which is the need the set a fixed price point to which the trade should stop. The trailing stop-loss, on the other hand, gives you the capability to keep your profits once it hits the stop-loss price.

A trailing stop can be set for both a long and short position. Either way, the tool can both protect your gains as the price moves up and stop losses. This is suitable for traders who react emotionally on both huge and small market events that result in either suddenly short selling shares before maturity or from holding on to shares for too long therefore potentially missing some selling opportunities.

Although it might seem simple, a thorough analyzation of a stock’s previous price movement and volatility levels is needed to ensure a successful trailing stop order while taking other things into consideration such as the trailing stop-loss order price going up as market share prices go up. The simplicity of it gives the trader an effective tool that can adjust your stop-loss price automatically as prices move higher.

Trailing Stop Advantage

Trailing stops are normally used in currencies and asset classes such as stocks, equities, and bonds.

Among the advantages of the trailing stop loss is that it ensures that your trade will exit once the share price suddenly turns into the downside. It also does not place a limit on the profits that you can earn as long as shares continue to rise without suddenly hitting a downside during the trading session. An investor may choose to discuss the terms of their brokerage regarding placing stop-loss orders or for customized trailing stop-loss plans.

However, one must remember that the trailing stop advantages does not guarantee that you will be able to sell at a price which will give you the best returns. This happens when a stock market price slumps at an unprecedented rate before a trader even gets to place his or her fixed stop price.

This can be avoided with the assistance of brokers and through a deep understanding of an asset’s specific price movement. The ability to predict any upcoming price decline in the midst of impending significant market or political events may also decrease the chances of selling the stock at an extremely low price.