Trailing stops are orders that stay in effect until triggered. Once triggered, trailing stops are converted into market orders, which are submitted for immediate execution. However, market orders do not necessarily result in a price that is the same as the trigger price. The percentage of the order’s lapse is dependent on how frequently the trigger price is recalculated, and the percentage may vary. Here are some common examples of how trailing stops work:
A trailing stop loss order limits the amount of loss that can be incurred by an investor. Unlike a standard stop order, a trailing stop limit order also includes a limit offset and is sent to the exchange after the stop price is triggered. A disadvantage of using a trailing stop limit order is that it can gap past the limit order in fast-moving markets, resulting in the order not being filled. However, this disadvantage is usually outweighed by its benefits.
In addition to limiting the amount of trading you can do with a trailing stop order, this strategy has other disadvantages. The most obvious disadvantage is that it makes it difficult to trade extremely volatile stocks. You risk incurring significant losses by setting a trailing stop loss order too low or too high. Additionally, it can result in unintended selling when the stock price makes a sudden, irrational decline. In such a scenario, a trailing stop order is not recommended.
A trailing stop can be manually set or automatically operated with most brokers. Regardless of the trading platform used, most trailing stops can be set to move automatically with your trades. Similarly, a trailing stop can be manually set to move with the price of a stock or currency pair. However, if you lose money, you won’t lose as much as you would with a normal stop loss. This option is most advantageous if you want to minimize your trading risks.
Traders should review their trailing stop strategy periodically to ensure that they are using the right level of protection. This means considering their trading consistency, their risk tolerance, and their financial situation. The optimal callback rate and activation price should be determined by looking at historical price changes and the trader’s profitability target. Furthermore, it’s important to determine how much you’re willing to lose in normal market conditions. In addition to the callback rate, a trailing stop should not have a very small activation price. A small activation price may trigger the trailing stop too early and could result in a losing trade.
The ideal trailing stop strategy depends on the trader’s personality and trading goals. It can be designed to follow short-term, medium-term, or long-term trends. Once the trader has chosen which trend to ride, he or she can then decide which trailing stop strategy is best for the trading style. If it’s the latter, the trailing stop should be based on the average true range. It’s not surprising that professional traders use trailing stop loss strategies to ride big trends. In fact, professional traders use trailing stop loss to lock in profits during a profitable move in a market and exit only when it reverses by X amount.