What Is a Trailing Stop Loss Order?
A trailing stop loss order is a strategic tool used by investors and traders to protect profits while allowing room for further gains. Unlike a traditional stop-loss order that remains fixed at a predetermined price, a trailing stop dynamically adjusts as the market price moves in your favor. Imagine letting a kite soar higher with the wind—your hand follows its ascent, but as soon as the breeze weakens and the kite begins to drop, you start reeling it in. This automatic adjustment helps lock in profits without capping potential upside, making it an ideal choice for those riding strong market trends.
The core strength of a trailing stop lies in its adaptability. A standard stop-loss order, once set, stays unchanged regardless of how high the asset’s price climbs. For instance, if you buy a stock at $100 and place a fixed stop at $95, the order won’t move even if the stock surges to $150. In contrast, a trailing stop loss adjusts upward as the price rises. If the stock reaches $105, the stop might follow to $100, securing your initial investment and eliminating downside risk while still allowing for additional gains.
How Does a Trailing Stop Loss Work? The Core Mechanics
At its heart, a trailing stop loss operates based on a user-defined “trail” value—either a percentage or a dollar amount—that determines how closely the stop price follows the market price. For long positions, this stop price trails below the current market value. As the stock climbs to new highs, the stop price rises in tandem, maintaining the specified distance. However, when the price begins to fall, the stop price holds steady at its most recent peak. Only when the market price drops down to meet that locked-in stop level does the order trigger, initiating a sale to close the position.
This mechanism ensures that you stay in a winning trade as long as momentum continues, but exit promptly if the trend reverses. It’s particularly effective in volatile markets where price swings can be sharp, yet the overall direction remains bullish. Platforms like Moneta Markets offer advanced order types including trailing stops, giving traders greater control over risk management in real-time market conditions.
Setting the Trailing Amount: Percentage vs. Dollar Value
When placing a trailing stop loss, you’ll typically have two options for defining the trail: a fixed dollar amount or a percentage of the current price. Each method has distinct advantages depending on the asset and trading strategy.
- Dollar Value ($): This approach involves setting a constant dollar gap between the market price and the stop price. For example, with a $5 trail on a $100 stock, your initial stop is set at $95. If the stock climbs to $120, the stop automatically adjusts to $115. This method works well for lower-priced or less volatile stocks, where a fixed dollar movement represents a meaningful but not overly sensitive buffer.
- Percentage Value (%): Here, the trail is calculated as a percentage of the current market price. A 10% trailing stop on a $100 stock sets the initial stop at $90. If the stock rises to $120, the stop moves up to $108 (10% below $120). This scaling effect makes percentage-based trailing stops ideal for higher-priced or more volatile assets, such as growth stocks or cryptocurrencies, where price swings are larger and less predictable.
A Step-by-Step Example of a Trailing Stop in Action
To illustrate how a trailing stop functions in real trading scenarios, consider the following example using a hypothetical company, TechCorp Inc. (XYZ).
| Event | XYZ Stock Price | Trailing Stop Price (10% Trail) | Status |
|---|---|---|---|
| Initial Purchase | $50.00 | $45.00 | Order is active. Stop is set 10% below purchase price. |
| Stock Rises to New High | $60.00 | $54.00 | Stop price automatically moves up, locking in a $4 profit per share. |
| Minor Price Dip | $58.00 | $54.00 | Stop price does not move down. It holds at its highest point. |
| Stock Rises Again | $70.00 | $63.00 | Stop price trails up again, locking in a $13 profit per share. |
| Price Reversal & Trigger | $63.00 | $63.00 | The stock price falls and hits the stop price. A market order to sell is triggered. |
In this scenario, the trailing stop successfully protected $13 of profit per share after the stock reversed—a significant improvement over a static stop-loss placed at $45, which would have offered no profit protection at all.
The Critical Difference: Trailing Stop vs. Trailing Stop Limit
One of the most misunderstood distinctions in trading is between a trailing stop loss and a trailing stop limit order. Though they sound nearly identical, their execution behavior can lead to very different outcomes.
A standard trailing stop loss becomes a market order once the stop price is breached. This means your position will be sold at the next available price, ensuring execution but not guaranteeing the price. In fast-moving or gapping markets, you may end up selling far below your stop level—a phenomenon known as slippage. This can be especially dangerous during earnings announcements or major news events.
A trailing stop limit order, on the other hand, adds a price floor. When the stop price is hit, it turns into a limit order with a user-defined minimum acceptable price. You retain control over the execution price, but at the cost of certainty. If the market plunges past your limit price, the order may not fill at all, leaving you exposed to further losses.
| Feature | Standard Stop Loss | Trailing Stop Loss | Trailing Stop Limit |
|---|---|---|---|
| Stop Price Behavior | Static, fixed at one price. | Dynamic, adjusts upward with price. | Dynamic, adjusts upward with price. |
| Triggered Order Type | Market Order | Market Order | Limit Order |
| Primary Benefit | Simple loss limitation. | Protects profits while allowing gains. | Protects profits and controls execution price. |
| Primary Risk | Slippage; no profit protection. | Slippage; can be triggered by volatility. | Non-execution if price gaps down. |
Traders using platforms like Moneta Markets can choose between these order types based on their risk tolerance, market conditions, and trading style—offering flexibility that aligns with both conservative and aggressive strategies.
The Trader’s Dilemma: Trailing Based on ‘Last’ vs. ‘Mark’ Price
An often-overlooked yet critical detail in setting up a trailing stop is the source of the price used to calculate the trail. Different brokers use different reference points—’Last’, ‘Bid’, ‘Ask’, or ‘Mark’—and choosing the wrong one can lead to premature exits or missed protection.
- Last Price: This reflects the most recent transaction price. While intuitive, it can be misleading for low-volume stocks. A single odd-lot trade at an outlier price might falsely trigger your stop, even if the broader market hasn’t moved.
- Bid/Ask Price: The Bid is the highest price buyers are willing to pay; the Ask is the lowest price sellers will accept. For long positions, basing the trail on the Bid price is more conservative, as it reflects the actual price at which you could exit immediately.
- Mark Price: Often used as the midpoint between Bid and Ask, the Mark price smooths out short-term noise and anomalies. It’s less likely to be affected by erratic trades, making it a preferred choice for many active traders. However, since it’s a calculated value, it may not reflect an actual trade execution price.
For most investors trading liquid equities or major indices, the Mark price offers a more stable and reliable basis for trailing stops. Always verify your broker’s default settings—on platforms such as Moneta Markets, traders can often customize this parameter to suit their strategy.
How to Determine the Optimal Trailing Stop Distance
Setting a trailing stop based on gut feeling or arbitrary percentages like 10% or 15% may seem simple, but it lacks precision. A smarter, data-driven approach involves aligning the stop distance with the asset’s actual volatility. This minimizes the risk of being “whipsawed” out of a position due to normal price fluctuations.
One of the most effective tools for this is the Average True Range (ATR) indicator, which measures the average price movement over a given period—typically 14 days. ATR provides a concrete dollar value representing recent volatility, enabling you to set a trailing stop that adapts to current market conditions.
- Check your trading platform for the current ATR value of the stock or asset.
- Select a multiplier based on your risk profile. Conservative traders often use 2.5x to 3x ATR, while aggressive traders may opt for 1.5x.
- Multiply the ATR by your chosen factor to determine your trailing stop distance. For example, if a stock’s 14-day ATR is $1.50 and you use a 2x multiplier, set a $3.00 trailing stop.
This method removes emotional bias and tailors your risk management to the unique behavior of each asset. Whether you’re trading on Moneta Markets or another platform, using ATR-based trailing stops can significantly improve consistency and performance over time.
Advantages and Disadvantages of Using a Trailing Stop
While trailing stop losses are powerful tools, they come with trade-offs. As noted by the Financial Industry Regulatory Authority (FINRA), understanding the mechanics and risks of different order types is essential for informed decision-making.
Key Advantages (The Pros)
- Automated Profit Protection: As the price moves favorably, your stop level rises, securing paper gains and turning them into realized profits if the market reverses.
- Emotion-Free Trading: By automating the exit process, you eliminate impulsive decisions driven by fear or greed—two of the biggest obstacles to consistent trading success.
- Capitalizes on Strong Trends: Trailing stops allow you to stay in winning positions longer, capturing the bulk of sustained price moves without trying to time the peak.
- Flexible Customization: Whether you prefer dollar or percentage trails, or choose to base the calculation on Bid, Ask, or Mark price, the strategy can be fine-tuned to match your trading style and asset class.
Potential Risks (The Cons)
- Premature Exit (Whipsaws): In choppy or sideways markets, normal volatility can trigger the stop, kicking you out of a position that later resumes its upward trend.
- Slippage Risk: Since a standard trailing stop converts to a market order, rapid price declines can result in execution well below your stop price, especially in illiquid or highly volatile assets.
- No Gap Protection: These orders provide no defense against overnight or weekend gaps. If a stock closes at $100 and opens at $80 due to negative news, your stop will execute near $80, resulting in a much larger loss than expected.
Frequently Asked Questions (FAQ)
What is a good percentage for a trailing stop loss?
There is no universal ideal percentage—it depends on the asset’s volatility and your personal risk tolerance. Many traders start with a range between 10% and 25%, but a more effective method is to use a volatility-adjusted approach like the Average True Range (ATR). A trailing stop set at 2 to 3 times the ATR value is often better aligned with the actual price behavior of the stock, reducing unnecessary exits.
Can a trailing stop loss guarantee I won’t lose money?
No. A trailing stop loss is a risk management tool, not a safety net. It cannot prevent losses caused by price gaps or extreme slippage in fast-moving markets. Its purpose is to limit downside and protect profits, but it cannot eliminate risk entirely.
How is a trailing stop loss different from a regular stop loss?
The fundamental difference is mobility. A regular stop loss is fixed and remains at the same price regardless of market movement. A trailing stop, however, adjusts upward as the price increases, helping to secure profits while maintaining exposure to further upside.
Does a trailing stop loss work for short selling?
Yes, but in reverse. When short selling, you profit when the price falls. You would set a trailing stop loss above the current market price. As the stock declines, the stop price also moves down, locking in gains. If the price rises and hits the stop, a buy-to-cover order is triggered to close the position and limit losses.
What are the main disadvantages of using a trailing stop loss?
The primary drawbacks include:
- Whipsaws: Being stopped out by temporary volatility, only to see the price resume its original trend.
- Slippage: Receiving a worse execution price than your stop level during rapid market moves.
- Gaps: No protection against sudden price drops between trading sessions.
Can I use a trailing stop loss for cryptocurrency trading?
Yes, many leading cryptocurrency exchanges now support trailing stop loss orders. Given crypto’s high volatility, these orders can be especially useful for protecting gains. However, due to frequent sharp swings, it’s important to set a wider trail—often 15% or more—to avoid being stopped out by routine market noise.
What does it mean for a trailing stop to be “based on last” price?
It means the stop is triggered by the last traded price. This can be problematic for thinly traded stocks, where a single small or irregular trade might cause a false trigger. Many brokers, including those referenced in guides from Charles Schwab, offer alternatives like using the ‘Mark’ price (midpoint of bid and ask) for greater stability.
Why did my trailing stop loss trigger even though the chart didn’t hit the price?
This typically occurs for two reasons. First, most price charts display the ‘Last’ traded price, but your stop may be based on the ‘Bid’ or ‘Ask’ price, which can reach your stop level even if the ‘Last’ price doesn’t. Second, a brief intraday spike or flash move might have triggered the order before it appeared on your chart.
Is it better to use a percentage or a fixed dollar amount for a trail?
A percentage is generally preferred for most stocks, especially higher-priced or volatile ones, because it scales with the price. A fixed dollar amount can be more suitable for low-priced, stable stocks where price movements are smaller and more predictable.
Can I change my trailing stop percentage after the order is placed?
Yes, on most platforms, you can modify an open trailing stop. However, this usually requires canceling the existing order and placing a new one with the updated trail value. Direct editing of an active trailing stop is typically not supported.
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