In the world of trading, there are numerous instruments that can help us increase potential earnings and reduce potential losses, which is why it’s crucial to understand how to use them effectively. We’ll learn about one of these techniques in this article, the trailing stop.
What is a trailing stop?
A trailing stop is a unique kind of trading order that adjusts in response to price changes. It can be an important part of your forex money management.
The trading stop moves up with the price when it moves up, but when it stops moving up, the stop loss price stays where it was dragged to.
When the market price advances favorably, a trade can continue to increase in value thanks to a trailing stop, but if the market price suddenly shifts unfavorably by a certain amount, the deal is instantly closed when the trading stop loss is hit.
Using a trailing stop, you can lock in the upside while automatically protecting yourself against the downside.
In that it automatically cancels the trade if the market moves in an unfavorable direction by a predetermined amount, a trailing stop order is similar to a stop loss order.
The main characteristic is that the trigger price will automatically follow the market price by the specified amount whenever the market price moves in a positive manner.
The major goal of this directive is to safeguard our operations’ profits and prevent them from dropping to zero in the event that the market flips around.
Since it operates automatically, this gadget is quite helpful when we are unable to be aware of our situations. Naturally, it only functions with our open platform, which must be live and running.
How to use a trailing stop loss?
As we have previously mentioned, the trailing stop ceases when the market shifts its trend and tracks the movement of prices in real time. The process basically goes like this:
The trailing stop for a long position rises with the market and stops when the price declines. When the price reaches the predetermined level, the position will be immediately closed.
When holding a short position, the trailing stop will follow the price’s downward movement and freeze when it increases. When the price reaches the predetermined level, the position will be immediately closed.
Only when it is touched by the price does the trailing stop loss become active. The operation with benefits will end at that point.
What’s an example of a trailing stop in forex trading?
- Let’s say you’re going long on GBPUSD and you set a 50-pip trailing stop after buying at 1.2550.
- If the price rises to 1.2600, your stop would also rise from its initial level of 1.2500 to 1.2550 (50 pips).
- The trailing stop will then stay at 1.2550 unless the price moves another 50 pips in your favour.
Why use trailing stops?
A trailing stop might be beneficial for traders who lack the self-control to lock in profits or reduce losses. Since it automatically safeguards your capital, it takes some of the emotion out of trading.
When an adjustable trailing stop is used, unlike a preset Stop Loss, it watches the direction of the currency pair’s price automatically and doesn’t need to be manually updated.
The trailing stop changes in real time as you move. Therefore, it’s a useful risk management tool when volatility is at its highest, allowing you to profit from quick market changes while safeguarding your position against a market trend reversal.
The trailing stop allows us to automatically update the stop loss when the market changes without having to sit in front of the screen all the time.
Additionally, it saves time for traders who hold positions in multiple assets at once because they don’t have to manually manage each position in order to reverse their stop loss.
The trailing stop not only safeguards scalpers from abrupt increases in volatility but also enables them to have a stop loss that will adjust to their position in real-time, which can be challenging to execute manually.
With the knowledge that the risk is under control in their open positions, intraday and swing traders can study new charts and search for new chances thanks to the trailing stop. As a result, this instrument gives you more confidence because it has an immediate impact on the trader’s mindset.
Drawbacks of using a trailing stop?
The stop level may be regularly triggered if you invest in a currency pair that is highly volatile, leading to a string of little losses. The expense of opening additional transactions could also reduce your profits.
You should give serious thought to your trailing stop quantity. The stop level may be triggered quite frequently if you are investing in a currency pair (or other asset) that is particularly volatile.
Excessive trading can soon develop into “churning,” where your profits are reduced by transaction costs (and commissions).
The trading platform must be connected to the broker’s servers for the trailing stop to work properly and to keep track of price changes in real-time. The trailing stop stops moving after we leave the platform and stays stationary at the last preset position.
What does that suggest? For your trailing stop to function properly as long as you have open positions, you must always keep your computer on and the trading platform open, or utilize a forex VPS (virtual private server).
The trailing stop is actually a professional advisor. In other words, it operates in the exact same way as a typical trading robot, which requires a constant connection to the servers to run.
Trailing stop loss vs fixed stop loss
A stop loss order and a trailing stop order serve separate purposes and should not be confused with one another.
The trailing stop is designed to secure prospective profits when the market moves in our favor, but the stop loss helps to limit losses in the event that the market is positioned against us, even though we can confirm that a trailing stop is a form of stop loss order.
A trailing stop differs from a stop loss in that it moves with the price whenever it moves in our favor and freezes when it moves against us.
Contrarily, the stop loss is always fixed at the amount we have chosen, regardless of the asset’s movement, and it will increase when the price of the asset approaches that level.
Final thoughts
If we know how to use the trailing stop effectively, it can help us manage risk better. Using a trailing stop loss, we are able to preserve a tiny portion of earnings in the event that the market moves in our favor before abruptly changing course.
However, your trailing stop could be activated by typical market movement and result in numerous losses and no gains if it is set too close to the current price. If it’s too wide, you run the risk of suffering needless big losses.
Before employing it, we must understand that it can occasionally result in premature position closing. The platform must also be open and functional in order for the trailing stop to move; otherwise, it would remain frozen as if it were a fixed stop loss.
Self-confessed Forex Geek spending my days researching and testing everything forex related. I have many years of experience in the forex industry having reviewed thousands of forex robots, brokers, strategies, courses and more. I share my knowledge with you for free to help you learn more about the crazy world of forex trading! Read more about me.
