Trailing Stop Order. Definition and Usage
A trailing stop order is effective in both optimizing profits and managing risk.
It continues to secure gains on a trade as long as the corresponding asset’s price moves in a favorable direction.
What is a Trailing Stop Order?
A trailing stop order is a stop order with a moving trigger point. It adjusts the price level at which a trade is executed based on the asset’s current valuation.
Both stop orders and trailing stop orders activate a market or a limit trade upon their underlying asset arriving at the stop price. While for a regular stop order the stop price is characterized by a fixed value, a trailing stop order defines it as a distance from an asset’s current cost. Unlike a fixed stop order trailing stop does not put a limit on an investor's potential profits.
How does a Trailing Stop Work?
In trailing stop orders, the stop price is expressed as a percentage or dollar amount above or below the underlying asset’s current market value. The distance between an asset’s price and the stop level is commonly called the trailing amount.
As the price of an asset moves in an investor’s favor, the trailing stop “trails'' it to secure profits on the trade. However, trailing stop does not follow the market in an unfavorable direction. While on a long position the trailing stop price only moves up, on a short position it only moves down.
Unlike a fixed stop loss order, a trailing stop order does not require manual adjustment of the stop price to match current market conditions.
When to Use a Trailing Stop Order
Trailing stop orders “lock in” gains as the price moves favorably and limits losses upon trend reversal. They are typically employed when trading in volatile markets.
Trailing stop orders are commonly used in combination with traditional stop orders. A fixed stop price provides an additional level of protection against price fluctuations in fast-moving markets.
Example of a Trailing Stop Order
Let's say a trader has bought the SOL/USDT (Solana/US dollar Tether) currency pair at 40 USDT. With a 15% trailing amount a trailing stop order to sell will be executed if the price of SOL/USDT drops to 34 USDT. In case the trading pair never climbs higher than 40 USDT the trailing stop will never move above the established line. If SOL/USDT does reach, for instance, 50 USDT, the trailing stop will increase to 42.50 USDT.
Pros and Cons of a Trailing Stop Loss Order
Pros:
- Limits losses. With a trailing stop order a trader knows in advance how much they can potentially lose on a position in an adverse market movement.
- Protects profits. Trailing stop orders follow an asset’s market price as it moves in a profitable direction.
- Automated. Does not require manual adjustment of the stop price to adapt to current market conditions.
Cons:
- An ideal trailing amount is difficult to determine. Placing a trailing stop too close to an asset’s market price can result in premature order execution, while an excessively large trailing amount can lead to unnecessary losses.
- As with regular stop orders, trailing stops don't protect investors from particularly drastic market moves. A trailing order stop price might not have a chance to be triggered if surpassed too fast.
Trailing Stop-Loss vs. Trailing Stop-Limit
A trailing stop-loss order is executed at the next best available market rate after reaching the stop level.
When placing a trailing stop-limit order a trader specifies a limit price — the price at which or better the order should be filled, in addition to defining a trailing amount.
Although trailing stop-limit orders provide investors with more control over the final order price than trailing stop-loss orders, trailing stops run the risk of never being filled should an asset never get to the limit price.
Trailing Stop Order FAQ
How does a trailing stop order work?
A trailing stop order calculates a stop level as a percentage or a dollar amount from the underlying asset’s market value. As an asset’s price moves in a favorable direction, the trailing stop follows it to lock in profits on a trade.
Why are trailing stop orders effective?
Trailing stop orders allow investors to automatically secure profits and minimize losses. They avoid putting a limit on potential gains by allowing the stop level to adapt to the current market state.
Which is better: stop-loss or trailing stop-loss?
Unlike a fixed stop order, a trailing stop automatically adjusts its stop price to follow favorable market movements. A trailing stop order continues to secure profits on a trade as long as the market moves to benefit an investor.
What is a good percentage for a trailing stop?
A trailing amount should be large enough to allow the trend to develop before executing the order but small enough not to incur unnecessary losses. The most commonly applied trailing amount is between 15% and 25%.
