Trading Academy

Lesson 26

What is a Trailing Stop

Many times, traders are faced with the dilemma of whether to close a profitable trade or keep it, in an attempt to get more. 

In such situations, there are two scenarios that can unfold: if they leave the position open, it might reverse and eat away all the profits; or they might close the trade for a profit and see it extending the move, and feeling bad for missing out on the potential profit. 

In such situations, a trailing stop might just be the solution. It is a method of protecting gains by allowing a trade to remain open and continue to profit as long as price continues in the right direction, but closing the trade if the price starts moving against you by a specified number of points.

Once you  set a trailing stop, it will automatically track the evolution of price and advance if it is favorable. That’s in contrast  to the fixed stop loss, which has to be manually reset in order to progressively lock in profits.

The big question when using trailing stops is the size of the increment used: a tight stop or a wide stop? A tight trailing stop might get you out of the market too soon, and you’ll miss any trading profits that may unfold.. unless you re-enter. A wider stop might allow more breathing room for price fluctuations, but it also exposes you to greater loss potential.

The motivation behind using trailing stops is to let your profits run. In a non-volatile trend, a trader will be able to make outstanding profits, until the trend eventually reverses and the stop is executed.

However, this requires repetition, discipline and experience in reading markets and identifying when a trailing stop would be appropriate. It also depends on your trading style, philosophy, strategy etc.

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