Investing 101: Trailing Stop Order

Trailing Stop Order

A trailing stop order is a type of a stop loss order. Under the latter, you set a price level, which if reached turns the stop loss order into a market order and requires your broker to sell the particular stock immediately. The selling of the stocks is executed at the best price currently available. Once placed, the order will adjust in price based on your settings that you set upon initiation of the trade.  It can be set in terms of actual dollars or set in percentages.  A Trailing Stop “Limit” order works the same way as a Stop “Loss” order except that once the order is triggered, it becomes a “Limit order” at a price that you specify instead of a market order.  There are “Trailing Stop” orders to help manage risk when buying stocks (going long), as well as when shorting stocks. When protecting your positions when buying stocks, they are sometimes called “Sell Trailing Stop” orders, and when helping protect any short positions you have, they are sometimes called “Buy Trailing Stop” orders.

The reason it’s so important to set a trailing stop order below support is that positions moving downward tend to bounce upward (reverse course) at or near their support levels. They may later begin to move downward again, break through support, and continue to move even lower.  A clear break below support is dictated by where a position closes, not by intra-day swings. Alternatively, after bouncing off support, a position may continue to move upward, never returning to the support level at all. For purposes of setting a trailing stop order, it doesn’t make sense to set a trailing stop order right at support because the position is almost certain to bounce up from that point, possibly reversing course. If you set your trailing stop order below support, it probably won’t be triggered unless the position has broken support and will continue downward.

A few points about trailing stop orders:

  • Stop order that continually adjusts the stop price based on changes in the market price.
  • A trailing stop to sell raises the stop price as the market price increases, but does not lower the stop price when the market price decreases.
  • A trailing stop to buy lowers the stop price as the market price decreases, but does not increase the stop price as the market price increases.
  • In both cases, the stop “trails” the market price.
  • When the stop price is reached, the order becomes a market order.
  • The same risk of market orders applies to trailing stop orders.

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