Trailing Stop Loss – Working Technique, Advantages and Disadvantages

Summary:
- A trailing stop-loss order helps us trade the stock market with discipline.
- It is a type of stop-loss order that helps combine both risk management and trading management.
- Modern brokerage companies integrate this method into their trading software and applications and it works somewhat automatically.
- The main difference between a trailing stop loss and a regular stop loss is that – a stop loss is placed at a specific price, but a trailing stop loss changes according to a specific formula and strategy as the price changes.
- A trailing stop loss can be determined and placed with the help of technical indicators.
- It is one of the most difficult decisions that traders always have to make, deciding when to book profits and when to cut losses.
Some traders will sell their shares as soon as the price of their shares increases slightly from the purchase price, and some types of traders will hold their shares until the current price trend reverses. Many people make mistakes while placing stop loss orders. Now let’s see how this mistake can be prevented.
Trailing stop loss order is one thing that helps us trade in the stock market with discipline. So let’s try to learn about this – how it works and discuss practical strategies.
What is meant by trailing stop loss?
Trailing stop is a type of stop-loss order that combines risk management as well as trading management.
Trailing stop loss is also sometimes referred to as – profit protecting stop, because this method works to protect the profits made from trading. This method is also effective in cutting losses by specifying the amount of loss if a trade is not successful.
Modern brokerage firms have incorporated this method into their trading software and applications, which works somewhat automatically. This method can also be applied manually by a trader.
How does a trailing stop-loss work?
A trailing stop-loss is first placed in the same way as a regular stop-loss order.
For example, if we want to place a trailing stop for a buy order, we would place it at a price that is below the trade entry price. The main difference between a regular stop loss and a trailing stop loss is that – in a trailing stop loss method, the trailing stop loss also changes as the price changes.
For example, for every 5 points that the price moves, the trailing stop will then change by five points.
The trailing stop loss moves in the direction of the direction of the trade. So let’s say a trader has a buy position that increases by 10 points from the current price, then according to the strategy, this trailing stop loss will also move towards the price by 10 points.
But in this situation, if a decline is observed in the price, the stop loss will not change in order to protect the overall trading money.
Let’s see how the trailing stop loss short position works:
For example, if we want to set a trailing stop for a short order, we will place it at a price that is above the entry price of the short position of the trade. Strategies for applying a trailing stop loss Can be set with the help of technical indicators:
1. Moving Average
To initially set this up, you can use: “Moving Average” The steps you need to follow are: First decide what type of trading you want to do: — Long trading or short trading [Long: Buy — Short: Sell]
Use appropriate moving averages
Close the trade when the price goes beyond the specified point
That is, if you want to do a long position (buy trading), you can trail your stop loss with the help of the 20-period simple moving average (20MA), as long as the price moves above the moving average, you can keep the position open by considering the 20 MA as the stop loss Close the long position as soon as the price breaks the 20MA or after closing below the 20MA
2. Average True Range Indicator
You can also use the Average True Range indicator to set a volatility-based trailing stop loss.
If you are a long position holder, then a trailing stop loss of minus X ATR from the high can be considered as a suitable trailing stop loss If you are a short position holder, then add X ATR from the bottom and this will be considered as your stop loss
Advantages :
If you are a long position holder and the price goes below the specified trailing stop loss price, the order will be automatically executed and the position will be squared off.
This method does not limit your profits. A stock price increase can be sustained for a long time, and you can maintain a position until the price drops below your stop loss.
The order system in this system is flexible. You can change your stop loss at any time to your desired percentage for a customized risk management plan. There is no additional cost for placing a stop-loss order. This method helps investors separate emotions from their trading.
Disadvantages:
- There is no guarantee that you will receive the price of your stop-loss order. Some brokers do not allow stop-loss orders for certain stocks or exchange-traded funds (ETFs).
- This method can be difficult to use on highly volatile stocks.
- If you do not receive a suitable price after placing this order, you will lose the ability to make a personal decision about whether to sell the stock or not while the order is in effect.
- The decision is entirely yours – whether you will trade this method to manage your risk or trade more traditionally.