What is Trailing Stop?

A Trailing Stop is a dynamic type of stop loss order used to lock in profits and limit losses. Unlike a fixed stop order, a trailing stop adjusts to changes in the market price, helping traders to lock in profits when the market moves in a favorable direction, while protecting profits when the market moves in the opposite direction. Below is a detailed explanation of trailing stops:

How Trailing Stops Work

1. Setting an initial stop:

• When placing an order a trader will set a trailing stop starting point, which is a distance relative to the current market price. For example, if you buy an asset with a trailing stop loss of 100 pips, then if the market price changes from 100 to 110, the stop loss will be adjusted to 110-100 pips, i.e. 110 pips.

2. Automatic Adjustment:

• When the market price moves in a favorable direction, the trailing stop will automatically adjust. For example, if you set a Trailing Stop Loss of 50 pips and the market price rises by 100 pips, the Trailing Stop Loss will be adjusted upwards by 100 pips to protect your profit.

If the market price moves in the opposite direction and reaches the trailing stop, the system will automatically trigger a stop loss order to help you exit the trade.

3. Fixed distance or percentage:

• Trailing stops can be set to a fixed price distance (e.g. 100 pips) or a percentage (e.g. 5%). Fixed distance is suitable for markets with relatively stable price fluctuations, while percentage is more suitable for markets with high price volatility.

Advantages of trailing stops

Let's say you buy a currency pair with a current price of 1.1000 and you set a Trailing Stop of 50 pips:

• If the market price rises to 1.1050, the Trailing Stop will be automatically adjusted to 1.1000 (1.1050 - 50 pips).

• If the market continues to rise to 1.1100, the Trailing Stop will be adjusted to 1.1050.

• If the market price falls back and touches 1.1050, the Stop Loss order will be triggered and the trade will be closed, locking in the profit from 1.1000 to 1.1050.

Limitations of trailing stops

1. Slippage Risk:

• Under extreme market conditions, trailing stops may be exposed to slippage, which is the difference between the actual execution price and the set stop price.

2. Market Volatility:

• In highly volatile markets, trailing stops may result in premature triggering, especially when market prices fluctuate dramatically over a short period of time.

3. Appropriate distances need to be set:

• Setting a trailing distance too close may result in frequent stop loss triggers, especially in highly volatile markets. Setting it too far away may not protect profits in time.

Trailing stops are an effective tool for managing trading risk and locking in profits, but they should be used in conjunction with market conditions and your personal trading strategy to achieve the best results.