Foreword
In previous article, we have gone through what is a stop order, an instruction sent from traders to their broker to buy or sell their securities when a specific price reached. However, we did not cover the trailing stop order in that article. So, here we are. After reading this article, you will know what is a trailing stop order. Also, examples and illustration would be given.
Recap of Stop Loss Order
A stop order is an order you sent to your broker to buy or sell your security when its price past your set trigger price. It could only be sent when you are holding a position (long or short) and will never be triggered as long as the security’s price does not reach the set trigger price. The Stop Orders are designed to minimize traders’ loss.
Related article: What is a Stop Order? Example with Illustration | Stocks
What is a Trailing Stop Order?
A bit different from the Stop Order, the trailing stop order could be used to lock up profit no matter if you are holding a long or a short position.
The trigger price of the trailing stop order can be set either at a defined percentage or a dollar amount away from a security’s current price. Besides, it would move along with the security price when the price goes in the direction that benefits you (one direction only)and help you to lock up profit if the market turns against you.
A Limit Order or Market Order could be preset to send when the trailing stop order is triggered.
Examples
To give you a clear picture, let me illustrate it with an example.
Trailing Stop Order (LONG)
Dollar Amount away from the current market price
You have sent a trailing stop order with a $0.5 trigger price lower than the security’s current price of $5. 5-0.5=4.5 would be the trigger price of your trailing stop order.
Possible Outcome
2a. If the price of the security rise to $6, your trigger price would increase to 6-0.5=5.5.
2b. If the price of the security plummets to $4.5 or lower, your stop order would be triggered.
Defined percentage away from the current market price
You have sent a trailing stop order with a 5% trigger price lower than the current price of $8. 8 x (1-5%) =$7.6 would be the trigger price of your trailing stop order.
Possible Outcome
2a. If the security price spikes to $10, your trigger price would increase to 10 x (1-5%) = 9.5.
2b. If the security price plummets to $7.6 or lower, your stop order would be triggered.
Trailing Stop Order (SHORT)
Dollar Amount away from the current market price
You have sent a trailing stop order with a $0.3 trigger price higher than the security’s current price of $4. 4+0.3=4.3 would be the trigger price of your trailing stop order.
Possible Outcome
2a. If the security price plummets to $3, your trigger price decreases to 3+0.3=3.3.
2b. If the security price rise to $4.3 or more, your stop order would be triggered.
Defined percentage away from the current market price
You have sent a trailing stop order with a 10% trigger price lower than the current price of $5. 5 x (1+10%) =$5.5 would be the trigger price of your trailing stop order.
Possible Outcome
2a. If the security price plummets to $3, your trigger price increases to 3 x (1+10%) = 3.3.
2b. If the security price spikes to $5.5 or more, your stop order would be triggered.
Final Thought
Acquiring how to use the Trailing Stop Order would help you to become a better trader. From my perspective, in contrast with the Stop Order, trailing stop order is more suggested to be used for maximizing your profit and managing risk. Learn and apply it when you are trading if you are not doing well at accepting loss and failure.
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