Many traders have heard of the truism, 'cut your losses short, and let your profits run.' However, if you are unfamiliar with a tool to help you implement this tried and true wisdom, it's time you familiarize yourself with the trailing stop. If you've never heard of a trailing stop, it's just like a regular stop order, except you can set it to move along with the market.
- A trailing stop is just like a regular stop order, except you can set it to move along with the market.
- The primary function of the trailing stop is to increase your profit lock as the market moves, without the need for you to intervene and adjust.
- If you set a tight stop close to your price and the price whips forward and back, your trailing stop is likely to be hit, so it's important to use it carefully.
- Trailing stops are a great trading tool that allows you to not only protect yourself but to lock in more and more profit, without watching the market every second.
Forex Trading Trailing Stop Strategy Example
Here is an example, let's say that you want to go long on EUR/USD, and you set an emergency stop that will be triggered if the market ultimately moves against you. After a day or so, the trade is completely in your favor, so you want to lock in some profit and see what happens. You could set a stop in positive profit territory, and make it a trailing stop. If the market continues to move in your favor, your profit lock will increase. That will continue to happen until the market flips back in the other direction and hits your stop.
The primary function of the trailing stop is to increase your profit lock as the market moves, without the need for you to intervene and adjust. The trailing stop functionality allows you to follow trends based on your comfort level. You don't have to monitor the trade constantly.
Another good example of how to use a trailing stop is for trading longer terms. You set your initial stop far away from the market and just allow things to develop. It works well for slow trading systems that lock in profit over months and days. I prefer to set a long-term target, and also have a trailing stop. It allows you to set up your entire trade early on and allow it to run its course.
The forex market runs 24 hours, six days a week. It is a fair amount of hours to monitor. Rather than getting no sleep and broken sleep, it makes better sense to set a trailing stop on your trade. The big benefit is that your profit lock increases while you sleep. The market will always do what it will do, and your trade will adjust itself or stop out.
Be Careful When Using Trailing Stops
If you are day trading, you need to be careful using trailing stops. The forex market is typically a little "whippy," which means that currency pairs can cycle up and down before moving their ultimate direction. If you set a tight stop close to your price and the price whips forward and back, your trailing stop is likely to be hit. So, it's something that you should use carefully.
Stops are meant to protect your capital, but aggressively setting them close to the price tends just to clean out your account little by little as you get stopped out over and over. I've seen many new traders try to lock in as little as five pips of profit when their trade is only ten pips in the positive. This tight of a stop is not the worst, but these are usually the same traders that will set a stop five pips below their current trade price. How you set stops always depends on your actual forex trading method, but it's good to be aware of setting them too close to a moving price.
Some of the newer regulations have changed the way that stops are handled. Position trading is a type of trading where you average your trade price. That is, you make a buy, the price drops and you buy more, your average price falls somewhere in the middle.
Some of the newer regulations in the US have disallowed partial profit-taking that used to be available. Brokers are in disagreement as to exactly how this is handled. However, if you set a stop on your newest trade, the broker will actually apply it to the oldest trade that you have in that pair. If you aren't mindful of this, it can cause you to accidentally realize a loss, even though your most recent trade is in profit.
In conclusion, trailing stops are a great trading tool that allows you to not only protect yourself but to lock in more and more profit, without watching the market every second.
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