What Is A Trailing Stop Loss And
To Implement One?
By Trading Secrets
Trailing Stop Losses (part 1)
After defining your trading float, setting your maximum loss, calculating
your stop losses, and also calculating your position sizing we now need
to discuss how we take profits. This will typically involve adjusting
your trailing stop loss. Traditionally what an inexperienced trader will
do is once they see a little bit of a profit in their trading account,
they want to crystallize that profit straight away. The psychological
reason for this is because they dont like to lose, and they falsely believe
that those profits are their profits, and they dont want to give them
back to the market.
The reason this strategy is doomed to failure is the fact that youre
not adhering to one of the cardinal rules of trading and that is to adjust
your trailing stop loss and let your profits run. The astute listener
may have realized that were starting to implement rules that adhere to
these cardinal rules of trading. For example, by setting our initial stop
loss, were cutting our losses short, and now we need to introduce a rule
that allows us to let our profits run, like adjusting our trailing stop
loss. By simply setting these rules, were going to be able to control
two important variables - whether or not we make a profit, and how much
profit were actually going to make.
Now, of the two types of exits, hopefully its the ones were about to
discuss now, the trailing stop loss methods, that youll get to implement
more often because these are the ones that are implemented once were
in a profitable situation. Adjusting your trailing stop loss has the potential
to help us gain large profits, but before we go any further, let me warn
you that they will also give some of our profits back to the market.
When people first hear this, theyre usually taken aback. However, youre
starting to realize that were never going to be able to peak the top
of the trend. I know and you know that its much better to stay with the
trend as it develops so we can let our profits run, and as the share price
turns, well exit.
A simple example can illustrate the importance of a trailing stop loss.
If we received a buy signal and we purchased XYZ stock, and set our initial
stop loss, because the stop loss doesnt move up, that is our initial
stop does not move if after purchasing XYZ, the stock runs up a few
hundred percent, unless we have a way to lock in the profit and then the
stock reverts all the way back down to our stop loss, and obviously wed
be kicked out of the trade. The result would be that we ended up losing
money even though theres some potential for some fantastic gains.
Obviously, we need a way to circumvent this ever happening, and thats
exactly what a trailing stop loss does. This form of stop is simply adjusted
on a periodic basis according to some sort of mathematical algorithm.
For example, depending on the trailing stop loss we use, after the first
day of trading if the price moves in our favor or even if volatility shrinks
then the trailing stop loss is moved in our favor. If the market then
moves against us enough for our stop to be triggered, we would still take
a loss, but it would not be as large as our initial stop loss.
The key to the trailing stop loss is that you need to continually
make adjustments to make sure that the stop is moved in our favor.
Of course, the way in which a trailing stop loss is calculated is
very similar to the way in which we calculated our initial stop loss.
The only difference being rather than calculating our trailing stop
loss from the entry price, we calculate our stop loss from the highest
price since entry.
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