A trailing stop is a type of stop-loss order that automatically adjusts as the price of an asset moves in your favour. It is designed to lock in profits or limit potential losses without requiring constant attention to market movements.

Unlike a standard stop-loss, which is placed at a fixed price and does not change, a trailing stop “trails” the current market price by a specified distance (either a fixed dollar amount or a percentage). This means that if the asset’s price increases, the stop price moves up accordingly. However, if the asset’s price begins to decline, the stop remains at its last level and will trigger a sell order if the price falls far enough.

Methods to Adjust Trailing Stop Distance

Traders typically adjust trailing stop-loss distances using one or more of the following methods:

1.ATR (Average True Range)

ATR measures average daily price movement over a set period (e.g., 14 days).

Traders set trailing stops based on a multiple of the ATR.

Example:

ATR = $2

Trailing stop = 1.5 × ATR = $3

Your trailing stop is placed $3 below the highest price reached since you entered.

2.Percentage-Based Trailing Stops

Traders may use a fixed percentage trailing stop, adjusted depending on:

The asset’s volatility

Their time frame

Risk tolerance

Example:

A growth stock may need a 10–15% trailing stop

A low-volatility blue-chip may only need 3–5%

3.Price Structure-Based Stops (Support/Resistance)

This method involves placing the trailing stop below recent lows or support levels. As price moves up and forms new support zones, the stop is moved accordingly.

This is more manual and discretionary, and works well for trend traders using technical analysis.

4.Moving Averages as Trailing Stops

Some traders use moving averages as dynamic trailing stop-loss levels.

Common moving averages:

20-period EMA (short-term)

50-period SMA (medium-term)

200-period SMA (long-term trend)

How it works:

You stay in the trade as long as the price stays above the moving average.

When the price closes below it, you exit.

This method is often used in trend-following strategies.

Benefits of Trailing Stops

Lock in Profits Automatically

As the price increases, the trailing stop ensures you retain gains if the price reverses.

Eliminates Emotional Trading

Trailing stops enforce discipline and reduce the temptation to hold on to a losing trade.

Allows Flexibility

Let’s you ride trends while still having a protective exit in place.

Low Maintenance

Once set, trailing stops adjust automatically, which is helpful for those who can’t monitor trades constantly.

 Drawbacks and Risks

Whipsaw Risk in Volatile Markets

In choppy markets, small price drops can trigger the stop too early, cutting off potential gains.

No Guarantee of Exit Price

If the stop is triggered and the price gaps down or there’s low liquidity, your sell may occur at a worse price than expected.

 

Lauren Hua is a private client adviser at Fairmont Equities.

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