What is a Trailing Stop and why is it worth getting familiar with it?
Modification of the STOP Loss order, often referred to as “moving STOP Loss”. It consists in automatic adjustment of the price limit during changes in the market price. In this way, we are able to continuously follow a larger additional profit.
Most traders consider any form of stop loss an essential element on the road to stock market success. Thoughtful hedging of trades, that is, consequently, among other things, risk management through sensible placement of defensive orders is very often a key factor in determining success.
Of course, we can also meet opponents of stop loss, who argue that exposing oneself to the risk of premature closure of a position, or the opportunity to show valuable information to the market and broker work against the player.
Much less discussion occurs with the Trailing Stop. Why? About that below.
Trailing Stop – types
The simplest definition of a Trailing Stop tells us that it is is an order that is primarily intended to protect the profit we have earned on a position, and not – as is the case with a classic stop loss – to protect us from loss.
Classic version – Trailing Stop
This is a variant in which it is assumed that the TS activates at the moment when the position earns the indicated profit in the TS parameter. For example, if we decide to set the Trailing Stop level at 30.0 pips then it will become active, only at the moment when our position earns a profit at the level of +30.0 pips. As a result, the TS level is set at the position opening level. In case, if we pass the SL then we will end the trade with a balance of 0.00 pips.
On the other hand, what if our profit continues to grow? Together with the next earned pip SL moves in the direction of profit and at profic +31.0 pips; SL – 1.0 pips, at profic +35.0 pips, SL – 5.0 pips.
If, on the other hand, the course is reversed, the SL level stays in place.
Manual version – Trailing Stop
It is possible to manipulate SL levels manually. In this way we get the possibility to precisely modify the SL levels at the moment we choose and by the distance we choose. On the other hand we have to watch the platform all the time.
Trailing Stop on Forex
Almost all Forex platforms have the ability Trailing Stop. It is worth remembering that almost all of them also require having a computer on at all times. There are also tools, such as Expert Advisors (EAs) or combiners, used for orders to use SL.
The advantage of this is that we can define the jump parameter, i.e. the distance by which the TS will modify our Stop Loss. Similarly, we can set TS = 20, but STEP = 10. As a result, our Stop Loss is modified by a jump of +10.0 pips, +15.0 pips, +20.0 pips and so on. Not many platforms have such solutions as standard.
The downside of this solution is the need to manage an additional tool, i.e., an automaton or combiner. It is worth remembering that using a custom TS any changes in parameters must occur exactly on the computer that was started.
It is worth remembering that when using the Trailing Stop, you should give the platform time to react. A jump in the price for a second upwards very often can prove to be short-lived – too short for our mechanism to work. As a result our SL remains in place, despite the fact that the chart suggests otherwise.
How to select the Trailing Stop parameter?
Keep in mind that there are both strengths and weaknesses of the Trailing Stop. The strengths certainly include the fact that our profit is secured continuously until the SL is hit, the TP is reached or the trade is closed manually. This protects us from the consequences of an unplanned change of direction.
The choice of the Trailing Stop parameter also depends largely on the strategy of operation. Systems based on movements with limited range or playing in consolidation usually do not need TS. Rarely it will also be needed in the case of scalping. Taking the risk of entering into a transaction, where the spread/commission has a large share of the possible loss leads to a situation, in which the use of TS becomes unprofitable.
The most sensible use of SL is when using trend-following strategies, day-trading, breakout plays, news trading and other methods that rely on a longer or more dynamic price change in a given direction.
How to determine the value of TS?
You can use two popular ways.
The first is based on a correction. In this technique, we measure the last significant correction of the movement we plan to join. We set the TS parameter at its magnitude and possibly increase it by a small margin of error.
The second solution is to use average volatility (ATR) or other tools that allow you to check the average range of price change over a given period. The most important thing here is the period of use. If we use day-trading and have an open position for most of the day then we should take into account the volatility of at least the last few days. If we are trading in the medium term then the period studied must cover at least several weeks.
