Table of Contents
1 Key Takeaways
- Trailing stops automatically adjust the stop price in line with the market price, protecting against downside risk and locking in profits.
- Trailing stops allow you to participate in potential upside while limiting potential losses.
- Using trailing stops can increase stop loss accuracy, minimize losses, and preserve profits in trading.
2 What Is a Trailing Stop?
A trailing stop is a trading strategy that adjusts the stop price in line with the market price.
This dynamic stop order moves upward alongside the market price, protecting against downside risk while also locking in profits.
The strategy is widely used in stock trading and crypto trading.
3 How Does a Trailing Stop Work?
when the market price increases, the trailing stop order automatically adjusts to the new market price, but always maintains the specified percentage or dollar amount below the highest market price.
This allows you to continue profiting as long as the price moves in your favor.
For example, if a trader sets a trailing stop at 10% below the market price of a cryptocurrency at $50, and the price rises to $60, the trailing stop will adjust to $54 (10% below $60).
If the price then falls to $54 or below, the trailing stop would trigger a sell order to protect the gains.
By using trailing stops, you can participate in the potential upside of a trade while limiting potential losses.
It allows you to stay in a trade as long as the price continues to move favorably, but protects against significant downturns in the market.
This makes trailing stops a valuable tool in managing risk and maximizing profits.
Join us to Boost Wealth
Stay Ahead With Cutting-Edge Trends and Insider Conversations!
4 A Quick Example of a Trailing Stop
Let’s say you purchase Bitcoin for $50,000, and you want to protect your investment from significant losses.
You decide to use a trailing stop order as an exit strategy.
Initially, you set the trailing stop at 5% below the current market price, which is $47,500.
As the price of Bitcoin rises to $55,000, the trailing stop is automatically adjusted.
Now, the stop loss is 5% below the new market price of $52,250.
If the price suddenly drops to $52,249 or lower, the stop loss is triggered, and your position is automatically sold.
This allows you to limit potential losses and protect your investment.
On the other hand, if the price continues to rise, the trailing stop moves with it.
For example, if Bitcoin reaches $60,000, the adjusted stop loss would be $57,000, still 5% below the market price.
The trailing stop not only protects you from significant losses but also allows you to lock in profits as the price moves in your favor.
In this example, if the price rises to $60,000, the trailing stop would guarantee a minimum profit of $7,000, as the stop loss is triggered at $57,000.
By using a trailing stop, you can effectively manage your risk and secure your gains, even when you are not actively monitoring the market.
5 Advantages of Using Trailing Stops
▍Increase Stop Loss Accuracy
Trailing stops allow you to limit losses and preserve profits by automatically adjusting the stop price as the price moves in their favor.
However, without accurate stop loss placement, you may exit trades prematurely or experience larger losses than anticipated.
To improve stop loss accuracy, you should consider several strategies and techniques.
First, setting appropriate stop limits based on risk tolerance is essential.
You should determine the maximum amount of loss you are willing to accept and set stop loss accordingly.
Utilizing technical indicators can also enhance stop-loss accuracy.
These indicators analyze price patterns, trends, and other market conditions to provide insights into when to exit a trade.
▍Minimize Losses
Trailing stops can be an effective strategy to minimize losses and preserve profits in trading.
A research study conducted by Kathryn M. Kaminski and Andrew W. Lo supports this idea.
The study examined the effectiveness of trailing stop-loss as a strategy for an arbitrary portfolio.
The findings of the study showed that incorporating trailing stops in the portfolio strategy significantly reduced losses.
This strategy ensures that losses are kept within a predetermined percentage or amount.
By implementing trailing stops, you can automate your exit strategy and protect your portfolio from significant downturns.
This approach is particularly beneficial in volatile market conditions where price movements can be unpredictable.
▍Preserve Profits
At the same time, trailing stops also allow you to lock in profits as the price rises.
If the market price moves in a favorable direction, the trailing stop order is adjusted accordingly, capturing gains and protecting you as the stock/crypto price continues to climb.
Boost Wealth with Leverage
Copy Expert Traders | 24/7 Trading Bots | The Top 5 Platform!
▍Reduce Trade Timing Risks
By utilizing trailing stops, you can greatly reduce the impact of trade timing risks.
Instead of constantly monitoring the market and manually adjusting your stop-loss order, your trading platform takes care of it for you.
This allows you to stick to your predetermined exit strategy and protect your investments.
It takes the emotion out of the equation and ensures that you’re not holding onto a stock/crypto for too long, potentially risking a downturn in price.
Trailing stop orders is particularly useful in volatile markets.
▍Provide a Hands-Off Approach
For part-time traders, trailing stop orders are especially useful.
With limited time to actively manage trades, these orders provide a hands-off approach to risk management.
Instead of constantly monitoring the market, trailing stop orders automatically adjust stop-loss levels, providing peace of mind.
These orders are most effective during standard market sessions and are available as both day orders and good-’til-canceled (GTC) orders.
It can lock in profits as the price moves in your favor, eliminating the need for constant monitoring.
6 Disadvantages of Using Trailing Stops
▍Missing Out on Further Gains in Price Movement
When using trailing stops, there is a potential drawback of missing out on further gains in price movement.
While trailing stops are designed to lock in profits and protect against losses, they can also limit the potential for gains if the stock/crypto price continues to rise.
Let’s say you purchase a stock at $50, and you set a trailing stop order at 10%.
If the stock price rises to $55, the trailing stop will be triggered at $49.50.
If the price adjusts to 48, your trade will be closed.
However, if the stock price continues to climb to $60, you have exited the trade and missed out on a further gain.
To prevent this potential drawback, setting the trailing stop at an appropriate distance from the current market price is crucial.
▍Whipsaw Effect
This occurs when the trailing stop order is triggered by short-term price fluctuations, leading to frequent buying and selling of the stock/crypto.
This can generate unnecessary transaction costs and potential losses.
Profit 24/7 with Grid Trading Bot!
Auto Buy Low Sell High via Spot and Futures
▍Not Suitable for Every Trading Strategy
Certain trading strategies may not be compatible with trailing stops.
For example, if you are a long-term investor who wants to hold onto a stock/crypto for extended periods, trailing stops might not align with your investment approach.
Market conditions also play a significant role in determining the effectiveness of trailing stops.
In stable or range-bound markets, where price moves are limited, trailing stops may result in premature exits and missed opportunities.
On the other hand, in highly volatile markets, trailing stops may be too sensitive to price fluctuations, resulting in frequent stop-outs.
▍No Flexibility To Change Settings During A Trade
Once a trailing stop order is executed, you are unable to make real-time changes to the stop-loss level.
This rigidity can have significant implications, as market conditions are constantly changing and the ability to adapt is crucial.
For instance, let’s say a trader sets a trailing stop at 10% below the current market price of Bitcoin, which is $50,000.
If the market starts to show signs of increased volatility or unexpected fluctuations, you may want to adjust the trailing stop level to ensure tighter protection for their position.
However, with trailing stops, this is not possible once the trade is initiated.
Without the ability to make real-time adjustments, you may miss out on potential opportunities to limit losses or secure profits more effectively.
It can also leave you exposed to larger losses if market conditions change rapidly and the initial trailing stop becomes inadequate.
If you need to adjust your trailing stop level, you will need to cancel your existing trailing stop order and place a new one with the desired level.
7 Risks of Using Trailing Stops
▍Stop Splits
Stock splits can impact the effectiveness of trailing stops, as they can result in a decreased stock price and a wider trailing stop percentage.
This may lead to a larger loss if the stock price declines.
▍Price Gap
Gaps occur when a stock’s price opens significantly higher or lower than its previous closing price.
In such cases, trailing stops may not provide the intended protection, as the stop price can be bypassed due to the gap.
▍Overnight Risks
Market closure poses a risk to trailing stop orders, as it means that the stop order will not be triggered until the market reopens.
This can leave your position exposed to potential losses during the closure period.
▍Volatility Market
Fast markets, characterized by rapid and volatile price movements, can also impact the effectiveness of trailing stops.
During such market conditions, prices can change quickly, potentially resulting in larger losses than anticipated.
▍Liquidity
If there is low liquidity in a particular stock or market, it may be difficult to execute a trailing stop order at the desired price, leading to potential slippage and increased losses.
Profit by Copying Expert Traders
Auto profit 24/7 on Bitget, the top 5 platform!
8 Types of Trailing Stop
▍Moving Average Trailing Stop
This strategy is setting a stop-loss order based on a moving average of the security/crypto price.
For example, let’s say you’re trading Bitcoin for $50,000.
You decide to set a trailing stop of 10% below the 50-day moving average.
If the price drops by 10% from the average, the stop-loss order is triggered, protecting you from further losses.
You can mitigate downside risk as the stop-loss order automatically adjusts based on the average price movement.
This approach allows you to stay in a trade as long as the price remains above the trailing stop.
Additionally, this strategy helps lock in profits.
If the price rises, the trailing stop keeps advancing with it, allowing you to capture more gains.
For example, if the price increases to $55,000, the trailing stop would move up to $49,500 (10% below the new average).
This way, you can secure a portion of your profits while still participating in the upward move.
▍Parabolic SAR Trailing Stop
This indicator is based on the concept of Parabolic Stop and Reverse (SAR) and provides trailing stop levels for buying and selling decisions.
Using the Parabolic SAR Trailing Stop, you can set two parameters: the acceleration factor and the maximum acceleration.
The acceleration factor determines the rate at which the trailing stop moves closer to the market price, while the maximum acceleration sets a cap on how quickly the stop can adjust.
Different settings of the acceleration factor and maximum acceleration can significantly impact the performance of the Parabolic SAR Trailing Stop.
For instance, a higher acceleration factor leads to a more aggressive trailing stop, which may result in faster exits and increases the chances of whipsawing.
Conversely, a lower acceleration factor provides a more conservative stop level, offering more staying power but potentially sacrificing profits.
By comparing the risk-adjusted returns of each setting, you can identify the most suitable configuration for their investment strategy.
Testing different settings of the acceleration factor and max acceleration can help you find the optimal balance between risk and reward.
You can use return-to-risk scores to evaluate the performance of each variation.
Lock on Crypto Before Price Pumps
Leverage On-Chain Metrics, Indicators, and Insights
▍Time-Based Trailing Stop
A time-based trailing stop is a type of trailing stop order that adjusts the stop price based on a specific time interval.
It allows you to set a fixed period after which the stop price is adjusted.
The main benefit of a time-based trailing stop is that it provides flexibility and adaptability to changing market conditions.
It takes into consideration not only the price moves but also the duration of the trade.
This makes it suitable for traders who want to capture medium-term trends and lock in profits without being overly concerned about short-term price fluctuations.
For example, let’s say you purchase Bitcoin at $50,000 and set a time-based trailing stop of 10%.
After 24 hours, if the price rises to $55,000, the trailing stop will adjust to $49,500 (10% below the highest price reached during those 24 hours).
This enables you to protect your gains and limit losses if the market suddenly reverses.
9 Tips for Using Trailing Stops
▍Know Your Risk Tolerance Level and Set Appropriate Stop Limits
Understanding your risk tolerance is essential because it affects your decision-making process.
Some investors are more conservative and prefer tighter stop limits to protect against potential losses, while others are more comfortable with looser stop limits, allowing for greater price volatility.
To assess your risk tolerance, consider factors such as your financial goals, investment experience, and time horizon.
Ask yourself how much loss you are willing to bear and how it would impact your overall investment strategy.
Once you have a good understanding of your risk tolerance level, you can set suitable stop levels for your trailing stop strategy. For example, if you have a lower risk tolerance, you may opt for tighter stop limits such as 2% or 3% below the current market price.
On the other hand, if you have a higher risk tolerance, you may choose to set looser stop limits like 5% or 7%.
However, you still have to consider the volatile nature of different assets to set the percentage.
Beginners’ Bot: Auto DCA-Buy and Sell
Buy More When Prices Drop, Auto Sell to Make Money
▍Set Appropriate Stop Limits According to Asset Characteristics
It’s important to set your trailing stop at an appropriate percentage below the current market price.
This percentage will depend on your risk tolerance and the volatility of the asset you are trading.
For example, a 5% trailing stop may work well for less volatile stock, while a more volatile asset may require a larger percentage.
For another instance, a 10 – 15% trailing stop for Bitcoin can be an option.
▍Adjust Trailing Stops According to Market Condition
Keep an eye on market conditions and adjust your trailing stop accordingly.
As the market fluctuates, it’s crucial to regularly review and update your stop loss order to ensure it is still providing adequate protection.
▍Pay Attention to The Costs
Each time your stop loss order is triggered and a trade is executed, there may be associated fees.
Therefore, it’s vital to consider these costs and factor them into your decision-making process.
▍Be Prepared for Unexpected Events
While trailing stops can help limit losses, they are not foolproof.
In volatile markets or during major news events, the price may experience sudden and significant movements, potentially causing your trailing stop to be triggered at a less favorable price.
10 Trailing Stop vs. Buy and Hold
Trailing stops can protect your investment from significant losses while still allowing for potential gains.
This strategy is particularly useful in volatile market conditions, where stock/crypto prices can fluctuate rapidly.
On the other hand, the buy-and-hold strategy is favored by value investors who believe in the long-term potential of their investments.
By holding onto stocks/cryptos for an extended period, you can potentially benefit from the growth and stability of the market over time.
However, it’s important to note that neither strategy is foolproof.
Trailing stops may trigger premature selling in situations where short-term market fluctuations do not reflect the true value of a stock/cryptocurrency.
Meanwhile, buy-and-hold investors may miss out on opportunities to take profits during market upswings.
To find the right balance, consider a hybrid approach.
This involves using trailing stops to protect against potential losses while still allowing for long-term growth.
Additionally, when selling stocks/cryptos, consider reinvesting the proceeds into other promising opportunities to align with the buy-and-hold strategy.
Buy your First Bitcoin and Make Money
Copy expert traders | 24/7 trading bots | Top 10 spot exchange
11 Final Thought
Trailing stops can be a valuable tool in your trading strategy, but they require careful consideration and practice.
Thoroughly testing trailing stop orders with small funds allows you to assess their effectiveness and refine your execution techniques.
Gaining practical experience and knowledge of proper execution techniques is crucial for successfully implementing trailing stops in live stock/crypto trading scenarios.
However, it is essential to be aware of potential risks, such as transaction costs and market crashes, and to adjust your trailing stop percentage according to the security price and volatility.
▍Ready to Become a Crypto Pro?
Follow us on X for cutting-edge insights and join our Telegram channel for real-time market discussion.
▍Limited Offers For You!
Platforms | Features | Offer! |
---|---|---|
Bitget Register |
Copying Trading & 24/7 Bots | Earn 1,000U* |
Pionex Register |
16+ Easy-To-Set Trading Bots | 20% Off on Spot Trading Fees! |
Bincentive Register |
Passive Income on USDT/USDC | 4.5%-8.25% Annual Reward |
Binance Register |
The 1st Exchange | 20% off on Trading Fees! |
Glassnode Register |
Trading Insights & Indicators | 10% off on Any Plan! |
*Note
1. Profits are not guaranteed. Providers may change any terms at any time.
2. It’s crucial to note that regulations may vary, and users from certain countries might not pass KYC requirements. Always check your local regulations before participating in any program.
3. Currently, the 20% off on transaction fees on Pionex is only available on spot trading. Please note that terms may be subject to change without notice.