As we have discussed on so many occasions one of the most important aspects of trading is risk management. You could spend hours or days researching entry level points for your trades, but if you don’t pay attention to risk management, your account will almost certainly be a losing account. Understanding order types, when and why traders use them can help you as a trader match an order type to your personal trading strategy.
With a standard stop loss you set the price or number of points away at which you want your trade to close out. This remains fixed, unless you yourself move it. A trailing stop loss order is a tool that the traders can use to gain better control of the trade. A trailing stop loss uses a trailing amount rather than a specific stated price to determine where the order is. You enter the number of points, or percentage that you want the stop to trail or follow a stocks price as it moves up (for sell stop loss orders) and down for buy stop loss orders. In other words, a trailing stop allows your trade to continue gaining in value whilst the market moves in a favourable direction, but the stop is automatically triggered closing the trade if the market suddenly moves in an unfavourable direction by a specified number of points.
Should the market price hit the trailing stop loss price it will close out the trade. As with all orders that are not guaranteed, the execution price could be below (for a sell order) or above (for a buy order) the trailing stops trigger price if the market gaps.
When to use a trailing stop?
With forex markets, trailing stops can be used throughout the trading week. Trailing stoops can part of your strategy from when the markets open on Monday morning in Sydney, to when the market closes at 9pm in New York.
Why use trailing stops?
Trailing stops are an excellent way of managing risk. As the price of the market moves higher (for a buy position), the stop is recalculated. Should the market price then fall lower, the stop price maintains its new trigger price, potentially capturing a profit or at least a reduced loss without you having to watch the trade.
Word of warning!
Trailing stops, as with standard stops must be used with some care and caution. If you only put a small distance between the market price and the stop, then the stop could be hit very quickly with even just a slight fluctuation in the fx pair triggering your stop. A drop of 20 points for example, is not actually much of a drop in forex markets and can be part of the natural flow of that fx pair. You don’t want to set this stop at such a small distance that it can be hit within normal trading fluctuations. This would guarantee a loss without giving your trade a chance to take off.
Trailing stops are designed to protect you from large losses, ironically if used carelessly they could actually end up increasing your losses.