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What is a trailing stop order, and how can I use it?
A trailing stop order can be used to protect a position (to limit the maximum loss) just like a normal stop order. Unlike a normal stop order, the trailing stop will follow the position as it becomes increasingly profitable. In this example, the client has bought Amerisourcebergen Corp. shares (ABC:xnys) @ 73 and has placed a trailing stop to protect the position.
This is the point of the trailing stop order: it gives you the possibility of protecting a position without the risk of taking profits too early. If the stock moves smoothly in one direction, your stop will follow it, until there is a pull back big enough for the stock to reach the stop price. This is an example of a trailing stop on a long position. A trailing stop could also be used to protect a short position.
When placing a trailing stop you need to set two parameters: "distance to market" and "trailing step":
- Distance to market: how far from the market price should the stop be placed?
- Trailing Step: by how much should the market move before the stop order re-adjusts?
Looking at the ABC:xnys-example in more detail, the stock was bought @ 73, the distance to market was set @ 7, and the "trailing step" was set @ 4. Here's the chart: in the 12 month period shown in the chart, the trailing stop loss order has adjusted upwards on 11 occasions.
When the shares were bought @ 73, the stop loss was set initially @ 66, because "the distance to market" was 73 - 66 = 7. As the shares moved up so, too, did the stop, but it moved up only in "steps". This is because the "trailing step" was set @ 4.
Here's how you would place a related trailing stop to an existing position:
1) Launch "Open Positions";
2) Click "Add stop order";
3) Select "Trailing stop";
4) Set the distance to market;
5) Set the trailing step;
6) Notice: you may prefer to not set a "take profit".
You will notice that you can click on the black "connector" between the "Price" and "Distance to Market". This will allow you to change between 2 ways of setting up the trailing stop:
- Input the price at which the trailing stop order must start. The system will then calculate what the distance to market should be;
- Input the distance to market that the stop order should start with. The system will then calculate what the initial level of the stop order should be.
The system will take into account the current market price to calculate these values correctly.
You can use trailing stop orders also on forex, CFDs, and futures, both on long and on short positions.