Trailing stops and stop-losses

Trailing stops lock in profits, whilst stop-losses limit losses. Using these effectively requires deeper understanding and experience than is outlined here. [The ‘sue yourself’ principle applies as usual.]

A stop-loss (sometimes just called stop) – is when you set a price where your trade is exited automatically.

If going long, in this scenario (you buy) – you expect price to climb, and great if it does. But you don’t know whether it will fall seconds, minutes after, or however long you’re in the trade. Price could simply plummet because the markets are random and you can’t see the future. Your acceptable loss is determined by the point below your entry price. So you calculate how much you are prepared to lose before entering the trade and set your stop loss. You go about your business and you don’t need to worry that price will fall say 1000pts and cause you to lose massively beyond your expectations.

But when to you exit the trade? That can be set by making limit stop. So you say to yourself, “if price rises 1500pts I want the trade to end, because I think that’s enough profit and I’ve hit my target.

trading_ratchet_trailing_stop_lossHowever, there are times when price has exceeded your upper target quite by surprise – and you may not have put on a limit stop. That’s a good position to be in. You may then want to end the trade manually, or you may want to see if price would rise more. But you don’t want to lose by price falling below your target which has already been passed on the way up. That’s when you need a trailing-stop.

The trailing stop ratchets up your stop-loss by certain increments that you decide. So you could for example, think, “if price rises by 10pts I want my stop-loss to move up by 10pts but I also want to give price enough distance to fluctuate without being stopped out too quickly.” That’s what your trailing-stop will do. (see diagram – clicking brings up larger view). [Trailing-stops can be used on the way down as well. Just apply the reverse principles.]

With your trailing-stop in place, you don’t have to stare at a chart or reach for a device to check prices – you’re cool. If price goes in your favour – you’re good. If it goes against you,  then you know that it will be caught by the last ratchet level ( the total of the step plus the distance, which you have set).

You could of course manually reset your stop-losses, if you have the time to do so.

There is one uncommon snag with stops and trailing stops. In very volatile markets you may not be stopped out exactly at the price you had set. That’s due to slippage and some time delay of the split-seconds it takes for messages to fly between computers etc. In most cases the slippage is not more than a few points. If you really need a total stop at the price you decide, then a guaranteed stop-loss can be set up at the entry point of the trade.

See here: How the SNB Could Change the Retail Forex Industry for Good by Sam Eder ( and funny video below. Well yes, it wasn’t funny at all for many people). This does not mean that panic should break out.

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