A trailing stop is an order that is aimed at limiting potential losses while preserving capital gains.
It cannot be repeated enough : arming yourself with safeguards is essential when it comes to trading. Alongside emotional control and knowledge, tools such as the trailing stop provide the security you need to be profitable in the long term in your investment strategy.
A highly useful precaution that ensures gains and limits potential losses, a trailing stop is an order that closes a position. In the financial markets, traders must optimize each investment. They have many tools at their disposal, of which the trailing stop is essential. According to the so-called trailing stop step, the price on which the trader is positioned will have to increase/decrease by a predetermined number of pips.
When this value is reached, there are two solutions :
Please note : a trailing stop is not set at a fixed value, but at a specific point spread that defines a maximum loss percentage over a given period.
Although the trailing stop only closes the position after a loss in value, it still allows for the validation of potential profits.
For example :
Note : Depending on whether you are buying or selling, the trailing stop will be positioned below or above the current price level.
The Trailing Stop is a variation of the classic stop loss.
At first glance, the use of the trailing stop has more advantages than disadvantages. However, the proportion of investors who use it remains low, and the classic stop loss remains more popular. In a way, the trailing stop offers more flexibility according to the market's evolution. Unlike the stop loss, it allows you to secure gains at the slightest loss in price value and limits losses just as well.
On the other hand, it is important to know how to place and set up the trailing stop and its step, otherwise, losses could be badly made up for and gains stopped too quickly. The trailing stop does not take into account the market context, especially its volatility. For this reason, many traders prefer to place a stop loss manually, while keeping an eye on it in case of a sudden drop in the trend. However, if properly set up, the trailing stop loss can be used to avoid the phenomenon commonly known as "fishing for stops".
Good to know : the term "fishing for stops" refers to the usual (and deliberate) decline in a price before going up again, and is driven by traders with sufficient funds to influence the trend.
By doing so, their objective is to safeguard traders who have placed their stop loss too close to the price. Placing a trailing stop at a sufficient distance from the price allows you to stay in the game and generate capital gains.
Of the four main trading strategies, swing trading is the most suitable for placing a trailing stop : trading strategies with a shorter time scale (such as scalping and intraday trading) expose the investor to too much volatility and uncertainty in the short term to place a trailing stop correctly. When it comes to swing trading, however, it is easier to analyze the medium-term trend and draw conclusions to place orders. It is therefore essential to have a solid knowledge of technical analysis as well as fundamental analysis on the financial markets, without which the novice trader will lack the information (and the skills) to know how to effectively anticipate trend reversals.
The trailing stop order is a variation of the stop loss that allows for more flexibility in securing gains and limiting losses, but also requires more expertise to set up correctly. Many investors prefer the classic stop loss. Given the in-depth knowledge required to place this order, it’s up to you to decide which of these two tools you wish to implement in your trading strategy.