What is a trailing stop?

What is a trailing stop? A trailing stop is a dynamic stop loss that reacts to the price of the instrument you’re trading.

If you’re in a buy trade, and the price of that instrument goes up, then the trailing stop will follow behind it, like a faithful Labrador.

This can be a brilliant way to lock in profits. … But it can also be a fast way to be bumped out of a trade, because your stop loss is way too tight.

What is a trailing stop doing to help you?

Let’s say that you’ve bought EUR/USD at 1.3650, and put your stop in 20 pips below at 1.3630.

Now, let’s say that the price moves up to 1.3680, bringing you 30 pips into profit.

If your stop loss is a trailing stop, it will move up with the price – so your new stop loss level will now be 30 pips higher, at 1.3660.

In this way, your trailing stop has locked in some of those profits, so if the market suddenly turns tail in the other direction, before you’ve taken your profits, you’ll still have secured some profits on this trade.

The benefits are two-pronged – you’re protecting profits that you’ve already made AND you’re leaving yourself in the market to benefit from further gains.

Here’s an example of how trailing stops can magnify our returns …

In this example, we’re able to make the most of a big move, even though we’re not watching the charts all day and monitoring our position.

In this next example, you can see how it can protect us from a sudden turnaround …

Here, the unexpected – a bleak forecast from the governor of the Bank of England – sent markets the wrong way. However, instead of losing 20 points on this trade, which is what would have happened with a normal stop loss, it managed to secure a 20 point profit.

How trailing stops help us be better traders

Trailing stops do offer us some great benefits, however I rarely come across a trader who’s profits are actually boosted by them. Perhaps those benefits are often more psychological than monetary.

While a trailing stop offers protection from sudden reversals, and lets us profit from big moves – it doesn’t always work in our favour. Often (and this is particularly true in a volatile market) a trailing stop will see us knocked out of a trade that would have run through to its profit target if you’d used a normal stop loss.

However – and this really shouldn’t be underestimated – a trailing stop allows us the luxury of asking “What if I let my position run?” And it offers us security from the “What if disaster strikes?” worry.

This can prevent impulsive behaviour – like leaving trades open beyond their profit targets, or nervous behaviour, like closing trades early, before targets have been hit.

I don’t believe that trailing stops are the best solution for all traders, but I do think it’s worth having an understanding of them, and testing them out on your trading strategy to see whether they have a beneficial effect on your results.

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The serious downside of the trailing stop loss How to use trailing stops