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Proven Techniques to Use a Trailing Stop Loss

All traders have the same dilemma at some point in their careers. When is it the best moment to take profits and when is it better to cut losses short? The decision is always tough. A trailing stop loss is to help market participants trade with discipline.

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Some investors prefer holding assets while waiting for the trend to reverse. Others will seek ways to sell stocks once the price has risen. The main challenge here is to avoid mistakes. So, using a trailing stop loss order is vital for an effective risk-management strategy.

In this article, we will explain how the instrument works as well as several ways to apply it under real market conditions.

What Is Trailing Stop Loss?

A trailing stop loss refers to the type of stop-loss orders. It comes as a combination of trade and risk management instruments. Additionally, the tool will make sense whenever you want to protect your profit from unexpected market moves. Traders use it to lock their profits on each of their trades.

A trailing stop loss order helps to protect the balance and the amount one can lose in case something goes wrong and the trade does not work out. The instrument is triggered automatically. No manual configurations are needed during a trade. It is launched by trading software that supports a chosen online broker. However, it is still possible to keep control over the process and use manual settings for the instrument.

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How Trailing Stop Loss Works

From the practical side, the instrument is placed similarly to a traditional stop-loss order. For instance, if you want to protect your buy order with a trailing stop loss, you need to place it at a price below the trade entry.

The main difference between the two orders is that the trailing one moves together with the price, which reserves more room for maneuver and makes your trading strategy a bit more flexible in terms of managing risks.

For example, if the price moves every 5 points, a trailing stop loss will also make a 5-point move. It does not matter how the price moves. The instrument will move accordingly in the same direction as the trade. However, if the price falls, the stop loss will not move.

How to Place a Trailing Stop Loss Order

Traders can apply several techniques to place this type of order. They will need specific technical indicators to support their choice and identify the best place to set the tool.

Using a Moving Average

A good idea is to set a trailing stop loss using a Moving Average indicator. All you need is to complete several simple steps:

  1. Decide on a long or short trade.
  2. Use the Moving Average accordingly (it should match either the long or short position).
  3. Make sure you exit a trade once the price has closed beyond a chosen MA.

Using Average True Range

Another popular technique is to use an Average True Range indicator. It helps to set volatility that is backed by a trailing stop. The following steps are to be considered:

  1. Select the Average True Range multiple you plan to use for a trade.
  2. If you choose to go long, deduct X ATR from the highs. It is going to be a trailing stop loss.
  3. If you decide to go short, add X ATR from the lows. Here is your trailing stop loss for a short position.

The process is quite simple. Setting the order does not require specific skills. You will only need some indicators that are already integrated into your MT4 platform.

Pros and Cons of Using a Trailing Stop Loss Order

The tool can be very handy, especially when the market is volatile and you do not want to lose potential profit. However, it comes with certain downsides and risks.

Pros:

  • The order works on autopilot. It will automatically sell an asset when the price drops.
  • You do not limit your potential profits with this order type. If the share price keeps rising, you will stay in the trade unless the value drops below a trailing stop loss.
  • The instrument adds some flexibility, as traders can enter any percent to keep their risk management plan easy to customize and change when needed.
  • A trailing stop loss order is free to place with no extra fees or costs.
  • It helps traders keep well-disciplined.

Cons:

  • No one will ever guarantee the price return of the stop loss order. What’s more, some brokers limit the usage of the tool. Traders cannot set it for ETFs and other specific assets.
  • The order is hard to implement when trading volatile stocks.
  • Investors can lose the sense and the ability to make decisions on whether to buy or sell the asset on their own relying more on an automated tool.

The Bottom Line

Definitely, a trailing stop loss is a great tool to keep new traders well-disciplined. It combines the features of trade and risk management approaches, making the tool flexible enough to stay invested. Users are free to use the tool as an automated mean or configure it manually. To set a stop loss, you will need to use specific technical indicators.

This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.