A trailing stop is a special type of trade order that moves relative to price fluctuations.
When the price goes up, it drags the trailing stop along with it, but when the price stops going up, the stop loss price remains at the level it was dragged to.
A trailing stop allows a trade to continue to gain in value when the market price moves in a favorable direction but automatically closes the trade if the market price suddenly moves in an unfavorable direction by a specified distance.
A trailing stop is a way to automatically protect yourself from the downside while locking in the upside.
A trailing stop order resembles a stop loss order in that it automatically closes the trade if the market moves in an unfavorable direction by a specified distance.
The key feature is that as long as the market price moves in a favorable direction, the trigger price will automatically follow it by the specified distance.
For example, setting a 50-pip trailing stop on EUR/USD after buying it at 1.2550 would mean that if the price rises to 1.2600, your stop would also rise from its initial level of 1.2500 to 1.2550 (50 pips).
Your stop will then stay at 1.2550 unless the price moves another 50 pips in your favor. This means that your trade will remain open for as long as the price doesn’t go against you by 50 pips.
Traders often make use of trailing stops to lock in profits while minimizing their risk.
Why Use Trailing Stops
A trailing stop can be good for traders who may not have enough discipline to lock in gains or cut losses.
It removes some of the emotion from the trading process since it automatically protects your capital.
There are some drawbacks to consider.
- You should consider your trailing stop amount very carefully. If you’re investing in a particularly volatile currency pair (or other asset), you could find the stop level triggered fairly frequently.
- Excessive trading can quickly turn into “churning,” with transaction fees (and commissions) eating into your profits.