What is a trailing stop order — how to use it?

As mentioned above, a trailing stop order is a type of stop-loss order that forms part of your risk management strategy. It tries to limit any potential losses that could occur in the market by specifying a specific point at which a trade could be closed if the market moves against you.

A trailing stop order will remain in effect until the position is closed automatically when the order is triggered or when you close the position manually.

This type of order is not set at a certain price level. Instead, it's set at a certain distance from the current market price, either in pips or as a percentage.

If you want to open a long position, it gets placed below the marker price; for a short position, it gets placed above the market price.

A trailing stop order works as a failsafe to secure potential profits if the market moves against your position while potentially limiting any losses. 

We already saw that it works by placing the order a certain number of pips or a certain percentage away from the market price. As the market moves in your favour, the trailing stop will automatically adjust to the price movement.

However, if the market stops moving and starts moving against your position, the trailing stop order will stop moving.

The position will be closed automatically when the market moves against you and triggers the stop order. Conversely, you could also close the position manually before the stop order gets triggered.

A trailing stop order could allow you to step away from the charts, giving you confidence that your position is being managed properly if the predetermined distance is set accurately.

We’ll look at an example later in this article to provide you with a clearer view of how it could work when trading the market.

Using a trailing stop order could be helpful in markets that have a defining trend, where the market is making a series of consecutive higher highs and higher lows in a bullish market or lower highs and lower lows in a bearish market. 

Before placing the order, it might be essential to consider the overall distance of the stop order from the market price.

If the stop order is placed too close to the market price, it could result in having the order getting triggered too fast, while placing it too far away from the market price could result in risking more of your capital as well as the potential profits you could’ve gained before the market reversed against you.

One way to get a better indication of the distance from where to place the stop order is to look at the historical price movements and market conditions of the financial instrument you might want to trade. Another way could be to use a technical analysis indicator such as the Average True Range (ATR).

It might also be essential to remember that a trailing stop order, like a standard stop-loss, might not be able to protect you from slippage.

Slippage occurs when there are market gaps and a significant difference between the previous closing price and the subsequent opening price. When slippage occurs, your trailing stop order could be triggered, but at a worse price than the predetermined set level. 

However, it is also possible for it not to get triggered due to the quick price movement.

In order to protect against slippage, you could use a guaranteed stop-loss order. To place this order, a broker will generally charge a small fee to ensure the order will be filled, even if slippage occurs.

Example of a trailing stop

Let’s say you have a short (sell) position open on EUR/USD at 1.07199, and you put the trailing stop 200 pips above the opening price. The trailing stop will adjust as the market moves upwards with each pip movement.

As the price moved down towards 1.06913, the trailing stop followed, keeping a distance of 200 pips at 1.07113. Next, the price moved towards 1.06662, and the trailing stop towards 1.06862. Lastly, it moved towards 1.06516, and the trailing stop towards 1.06716.

The price started reversing after reaching 1.06516, causing the trailing stop order to stop moving. As the market moved up, the trailing stop was triggered at 1.06716.

As you can see, using a trailing stop order might allow you to protect more of your profits compared to standard stop-loss orders.

Lastly, trailing stop orders don’t have an expiry time, so you can keep the order active indefinitely until it gets triggered and the position is closed automatically. Or you could close it manually before the price reaches the stop order level.

There are several benefits to placing a trailing stop order. Below is a list of some benefits involved.

• Having a trailing stop order could protect and lock in potential profits while limiting possible losses.
• It could also prevent you from holding onto a position for too long when the market starts moving against your position.
• It’s less time-consuming, as you won’t necessarily have to constantly monitor the charts, as a trailing stop automatically adjusts with price movements as the market moves in your predicted direction. 
• It offers flexibility while removing the emotional aspect of manually adjusting your stop-loss. This is especially true when trading in a volatile market, as speed is crucial due to the quick price fluctuations.
• When the market reverses, a trailing stop order might be able to capture that reversal sooner rather than having to adjust your stop-loss level manually.

A trailing stop order is ideal for any trading style, whether scalper, day trader, swing trader, or position trader.

There are also potential risks involved with a trailing stop order, which you might want to keep in mind before potentially using this type of stop order. Let’s have a closer look at some of those risks.

• A trailing stop might not be helpful for all market conditions. For example, when the market for a financial instrument is range-bound, meaning there is no distinctive trend, it could prove challenging to know what the distance should be from the market price.
• It might also not be helpful for financial instruments experiencing higher volatility levels because of the quick and frequent price changes. With higher volatile markets, your trailing stop order could be triggered more quickly, limiting any potential profits.
• Suppose the trailing stop is too close to the market price. If that’s the case, your order could be triggered too soon when the market moves against you, especially when volatility is higher.
• Now, suppose the trailing stop is placed too far away. In that case, the opposite could also occur, which is when the market starts moving against your position, the losses accumulate before the trailing stop order gets triggered. 
• As previously mentioned, a trailing stop order isn’t immune to slippage - just like a standard stop-loss order. When slippage occurs, the order may be triggered at a worse price than when the initial trailing stop order was placed, which could affect any potential profits gained.
• When this gap (slippage) occurs, there is also a possibility that the stop order may not be triggered at all due to these quick price movements.

The two most popular types of stop orders traders generally use are trailing stop and standard stop-loss orders. However, there are some differences between these two types of orders, which is why we’ve created a table to help you better understand them.

A trailing stop order is essential as it forms part of your risk management strategy to assist you by having this order automatically adjust the stop level to try and limit potential losses when the market starts moving against you while locking in potential profits gained during the trade.

Using this order also lets you stay in the trade for longer while the market moves in your favour - providing you with a certain level of reassurance - knowing your risk management is under control.

Emotions can also sometimes negatively impact a trader’s decision-making process. However, this type of stop order removes some of that stress, as the trader knows their exit strategy is being handled.

This allows traders to focus on their trading strategy while avoiding impulsive decisions, such as exiting a trade too quickly or holding onto losing trades for too long, possibly reducing the anxiety associated with trading.

Lastly, using a trailing stop order could also be less time-consuming as you might not have to constantly monitor the markets and/or manually adjust your stop order.