Trading has a separate set of tools to help protect positions when deals are already open. The most famous is the standard stop loss order. In addition, there are all sorts of trailing stop advisors. But today I want to show you another interesting way to limit the risks in a transaction. I will talk about the trailing stop.
What is trailing stop
This tool is a variation of the standard stop order. But it differs from the latter in that it can shift automatically towards profit. As soon as you set a trailing stop, you also need to set a certain distance at which it will follow the price.
By the way, if you literally translate trailing stop into Russian, you get a “tracking stop”. Not all traders use this tool, limiting themselves to the standard stop loss. Perhaps after reading this article your opinion will change, and you will take it into your arsenal.
So, I already briefly talked about what trailing stop is. But how does all this work in practice? I will give an example. To start, let's analyze trading with a standard stop loss. Suppose I opened a EUR / USD deal to buy at the 1,1200 level. My stop loss is at the 1,1190 level. The risk in this case is 10 points.
Suppose an hour later the price rose to 1,1210. Naturally, closing at this level does not make sense. With my stop size, it is advisable to hold at least 1,1220 so that the risk to profit ratio becomes 1 to 2.
I see that there is potential for growth. But at the same time, the deal is already profitable and it would be nice to somehow insure yourself in case of unforeseen circumstances. In this situation, many traders, like me, decide to move the stop to the opening level.
In my example, this is the 1,1200 mark. Why is this done? If a sudden drop happens, I will break even (of course, minus the spread, but I will not consider it in this example).
Thus, I moved the stop loss up by 10 points in the direction of the price movement. Now imagine that all this can be done automatically. By setting a trailing stop, you set the distance at which it will go for the price. But you can also use adviser with a trailing stop.
How does it work in practice?
Now consider the technical side. So, you set the trailing and set the distance, for example, 10 points. The transaction is open for purchase. If the price has risen by 1 point, your trailing also changes in the direction of growth by 1 point. The price increased by 10 points, the trailing stop level also increased.
And what happens if the price goes down? In this case, the trailing stop works like a regular stop order. Nothing changes. It remains at the same level as it was before the decline. As a result, with growth, the trailing stop also grows (if it was set in a buy transaction), and with a decrease it remains in place.
If you open a deal for sale, here it is the other way around. If the price decreases, the trailing stop will decrease by the same amount of points. If the price starts to move up, the trailing stop will stop. When the price reaches this level, the transaction will automatically close.
How effective is the trailing stop
This tool has both its clear advantages and disadvantages. It all depends on the specific situation on the market and your approach to work. Some traders find it useful, others say that this tool can knock out a position ahead of time.
Both of them are right. As I said above, it all depends on your approach. If you transfer an ordinary stop loss after the price, then a trailing stop will be helpful. This is a rather conservative approach, but it has the right to life.
If you prefer to leave the stop loss in its original place, then you will not need a trailing stop either. There is a category of traders who is ready to risk the amount inherent in the stop loss until the end of the transaction. This category never tolerates stop loss for the price as in the process of working it prefers to squeeze the most out of the deal.
In part, I agree with such traders. Fluctuations can be significant, and the deal does not have time to be bargained and will be closed in a stop.
The main advantages and disadvantages of trailing stops
Now consider the advantages of using this tool. There are a lot of them:
- Limitation of losses (this advantage applies to all stop orders, not only to trailing stop).
- A kind of guarantee against losses during a sharp price reversal. And indeed it is. If the trailing stop reaches the breakeven level, then, even with an unfavorable outcome, you will not lose anything.
- Partial automation of trade. If you put such a stop order, you do not need to constantly monitor the market and move your stop loss manually.
- Significantly expanding trading opportunities. Partial automation opens up more room for maneuver. You can work with several positions.
As you can see, there are many advantages. But there are also disadvantages. These include:
- The execution of this order occurs on the client side. This means that when the terminal is turned off, such an order will not work. This is bad and even very bad. If a connection breakdown occurs, your trailing stop will not work. Therefore, in case of weak Internet, I would recommend a safety net from a standard stop.
- The installation of a trailing stop should be approached very carefully. If the usual stop loss is always set, it is advisable to set trailing only when a strong and recoilless trend is planned. Otherwise, the market will quickly throw you away and have to re-enter at a less convenient price.
- Trailing stop can be set only after the order is triggered. It cannot be adjusted before the position is opened, as is done with the usual stop loss.
Should I use a trailing stop?
This is an individual issue. And even if you already use this type of order, it is also individual for you based on the situation. In the shortcomings, I pointed out that it is advisable to put it only when you assume that there will be no sharp and strong price kickbacks. A strong corrective movement will simply knock out your position.
Personally, I often resort to working with this tool, as I prefer trades closed at breakeven to trades closed at the usual stop order (that is, with losses). I can’t say that there were many cases when the trailing stop let me down a lot and closed positions with great potential.
On the other hand, if you do not want to work conservatively and are considering great prospects in the transaction and even use a trailing stop advisor, you can add to the trailing stop position only when there is no prospect of strong corrective movements.
With news trading, I would not set up trailing just for the reason that strong fluctuations in both directions are possible. Here, an ordinary stop is knocked out quite easily. And trailing all the more. On the other hand, if there is a strong trend after the news is released, you can quickly add trailing at a certain distance and record at least part of the price movement in the event of a sharp turn in the future.