Trailing stop loss orders are stop loss orders which are considered better than normal stop-loss orders. Like normal stop-losses they limit losses; but can also be used to protect the profits.
With trailing stops, traders can specify the stop-loss level at a percentage or price below or above the current market price. The stop-loss level is re-calculated every time the price moves in the direction of the trend. But when the trend reverses, the last calculated stop loss stays intact and the order is executed when the price hits the stop loss price. Trailing stop loss orders are of two types.
Sell trailing stops: They are used for closing long positions. The trailing stop losses are placed at a percentage or price below current market price. The stop loss rises with the price but does not fall with the price. Orders are executed when the price falls to hit the stop-loss level. Eg: a 10% sell trailing stop loss order placed when a stock is trading at $50 will create effective stop loss of $45 (10% subtracted from $50), when the price rises to $60 the stop becomes $54 and when the price hits $70 it becomes $63. Now if the price declines from there, the stop-loss won’t change and the order is executed at $63.
Buy trailing stops: Is just the reverse of sell trailing stops and are used for closing short positions. The stops are placed above market price. Their value declines as price declines but does not rise with the price. Eg: 10% buy trailing stop loss order placed when the price is at $50 will create an effective stop-loss of $45. When the price falls to $40 the stop becomes $36. But if the price rises from there, the stop-loss remains at $36 and the orders are executed when the price hits $36.
Trailing stops are very useful trading tools. Many traders use them together with other trading indicators, like volatility and momentum indicators, to get more accurate or custom exit points. For more information, read Setting Stop Losses and Parabolic Stop and Reverse (SAR).
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