A trailing stop loss is a type of day trading order that lets you set a maximum value or percentage of loss you can incur on a trade. If the security price rises or falls in your favor, the stop price moves with it. If the security price rises or falls against you, the stop stays in place.
Learn more about trailing stop losses so you can decide if and when they might be worth using in your day-trading strategies.
What Is a Trailing Stop Loss?
A trailing stop loss is a kind of order that is intended to help you lock in profits while protecting you from day trading losses. It caps the amount that will be lost if the trade doesn't work out but doesn't cap the potential gain if the trade works in your favor. This type of order converts into a market order when the security price reaches the stop price.
Because your trade will be carried out at the then-available market price, it may be executed at a price somewhat above or below the stop price.
Trailing stops can be set up to work automatically with most brokers and trading systems or can be manually monitored and changed by the trader.
How a Trailing Stop Works
A trailing stop-loss order is initially placed in the same manner as a regular stop-loss order. For example, a trailing stop for a long trade (selling an asset you have) would be a sell order and would be placed at a price that was below the trade entry point. The main difference between a regular stop loss and a trailing stop loss is that the trailing one moves whenever the price moves in your favor.
For example, for every five cents that the price moves up, the trailing stop would also move up five cents. If the price moves up 10 cents, the stop loss will also move up 10 cents. But if the price starts to fall, the stop loss doesn't move.
Let's say you enter a long trade at $40, with a 10-cent trailing stop at $39.90. If the price then moves up to $40.10, the trailing stop would move to $40. At $40.20, the trailing stop would move to $40.10.
If the price then moves back down to $40.15, the trailing stop would stay at $40.10. If the price continues down and reaches $40.10, the trailing stop-loss order would be converted to a market order, and you would be able to exit the trade at about $40.10, having protected about 10 cents of profit per share.
|Long Trade Trailing Stop|
|Price||Price Movement||Trailing Stop Loss||Profit|
The scenario for a short trade (selling a borrowed asset and then waiting to buy it back at a cheaper price) is similar except that you are expecting the price to drop, so the trailing stop loss is placed above the entry price. Let's say you're entering a short trade by selling borrowed stock at $20 a share. With a 10-cent trailing stop-loss order, you would be "stopped out" with a 10-cent loss if the price moves up to $20.10.
If the price instead drops to $19.80, the stop loss drops to $19.90. If the price rises to $19.85, the stop loss stays where it is. If the price falls to $19.70, the stop loss falls to $19.80. If the price rises to $19.80, or higher, your order will be converted to a market order and you will exit the trade with a gain of about 20 cents a share.
|Short Trade Trailing Stop|
|Price||Price Movement||Trailing Stop||Profit|
Criticisms of Trailing Stops
One major complaint about trailing stop-loss orders is that they can get you out of a trade too soon, such as when the price is only pulling back a bit, not actually reversing. To try to prevent that scenario, trailing stops should be placed at a distance from the current price that you do not expect to be reached unless the market changes its direction.
For example, a market that usually fluctuates within a 10-cent range while it is still moving in the same overall trending direction would need a trailing stop that is larger than 10 cents—but not so large that the entire point of the trailing stop is negated.
Another criticism is that trailing stops don't protect you from major market moves that are greater than your stop placement. If you set up a stop to prevent a 5% loss but the market suddenly moves against you by 20%, the stop doesn't help you because there won't have been a chance for your stop to have been triggered and your market order to have been filled near the 5% loss point.
Alternative to Trailing Stop Loss
The main alternative to a trailing stop-loss order is the trailing stop limit order. It differs only in that once the stop price is reached, the trade is executed at the limit price you have set—or a better price—rather than at the then-available market price.
How to Place or Move a Stop Loss
Most brokers provide a trailing stop-loss order option. Determine how much room you want to give the trade, such as 10 to 20 cents, and double-check your order. Your stop loss should now move automatically as the price moves.
Traders can also trail their stop loss manually. They simply change the price of their stop loss as the price moves.
- A trailing stop loss is a type of trading order that lets you set a maximum value or percentage of loss you could incur.
- The stop price moves with the market price when the market is moving in your favor; it stays in place when the market is moving against you.
- This type of order is meant to lock in profits while protecting you from significant losses.
- It converts into a market order when the security price reaches the stop price and is executed at the then-available price.
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