Trailing Stops in Practice
A trailing stop automatically adjusts a stop loss order's price level as a trade moves increasingly further into profit, allowing a trader to lock in a progressively larger share of an accumulating gain while still leaving the position genuinely open to capture any further, continued favorable movement.
This opening lesson in the Advanced Order Management course explains precisely how a trailing stop works mechanically, how to choose an appropriate trailing distance for a given trade, and the specific circumstances under which a trailing stop genuinely isn't the most appropriate tool to use. Building directly on the basic stop loss concepts covered extensively earlier throughout this Trading Academy, this lesson introduces a considerably more dynamic, actively adaptive variation of that same familiar underlying protective order.
How a Trailing Stop Works
A trailing stop automatically moves in the direction of favorable price movement, maintaining a set distance, but never moves backward against the position.
This means it can only tighten in the position's favor, gradually locking in more of the accumulated unrealized gain over time.
- Automatic Adjustment: A trailing stop automatically moves along with favorable price movement, maintaining a fixed, predetermined distance behind price.
- One-Directional Movement: A trailing stop only ever moves in the specific direction that protects an existing, already-accumulated profit.
- Hands-Free Management: A trailing stop meaningfully reduces the need for constant, manual stop loss adjustment during an active trade.
- Locking In Gains: A trailing stop helps secure a progressively larger share of profit as a favorable trade continues to develop.
Choosing a Trailing Distance
Choosing distance requires balance: too tight risks premature triggering, too loose gives back more profit than necessary.
Many traders base the distance on ATR-based volatility, keeping it appropriate to the instrument's current conditions.
- Too Tight: A trailing stop set too tightly risks closing your trade prematurely on entirely normal, ordinary short-term volatility.
- Too Wide: A trailing stop set too widely can give back considerably more accumulated profit than genuinely necessary before triggering.
- Matching Market Conditions: Your chosen trailing distance should genuinely reflect that specific instrument's own typical current price movement.
- Testing Before Live Use: Confirming that your chosen trailing distance works well on a demo account first is a genuinely worthwhile step.
When a Trailing Stop Isn’t the Right Tool
A trailing stop isn't always right, particularly in choppy, range-bound conditions where it can trigger repeatedly on normal noise.
In these conditions, a fixed take profit or manual approaches from later lessons may prove more appropriate.
- Automatic Profit Protection: A trailing stop automatically locks in an increasing share of profit as price continues moving favorably.
- Choosing the Right Distance: Setting your trailing distance too tightly risks early exits, while too wide gives back unnecessary profit.
- Best in Trending Markets: Trailing stops generally work considerably best specifically when a genuinely clear market trend is already in place.
- Avoiding Choppy Markets: Range-bound, directionless market conditions can trigger a trailing stop repeatedly and prematurely.
