How To Use A Trailing Stop Sell: Guide

by Jhorton Jennifer Marketing Consultant

Trailing stop sell is a special type of stop-loss order that combines two concepts. First, it trails the price, and secondly, it comes with a stop loss component. The trailing component is designed to track price as it moves lower, allowing traders to remain in the market as a trade moves in their favor. The stop loss component, on the other hand, closes a position as soon as price reverses.

Therefore a trailing stop sell is a stop-loss order used to mitigate losses and lock in profits in a short position. The order is opened when the price is moving lower and slightly above the point at which a trader enters a short position. Some traders opt to trigger the sell- order after the price has moved lower significantly.

Trailing stop order stand out compared to fixed stop-loss order given their ability to respond to price changes. While a normal stop loss is stagnant, trailing stops orders move as price moves. Therefore it does not need a trader or a forex robot to reset it from time to time, all in the effort of locking in profits.

The trailing feature in such market orders allows the sell orders to move or track the underlying price as it moves lower. Therefore the order allows traders to lock in optimum profits depending on price movements. In addition, it averts the risk of seeing profits disappear for holding profits for too long.

Example

A trader decides to sell stock XYZ trading at $10 a share on the belief it is overvalued and likely to continue edging lower. Likewise, he places a trailing sell order at 5% to mitigate against any price movement on the upside. At the start, the trailing stop order would be at the 10.50 level.

Once the price edges lower to the $9 level, the trailing stop order will trail the price and adjust itself at $9.5. Likewise, as the price pushes lower say to $8 a share the trailing stop order will also trail the price move lower to the $8.40 level.

As it can be seen above, the trailing stop order tanks as soon as the underlying price moves lower. As soon as price reverses and price starts to move up, the trailing stop sell order will not move. Instead, it remains fixed at the last price point. In this case, the sell component of the trailing stop will remain fixed at $8.40 and will close out the sell position as soon as the price bounces back to the price point.

As soon as price closes out, a trader would make a profit of ($10-$8.4) 1.6 on the sell position, opened at the $10 mark.

Advantages of Trailing Stop Sell Order

The sell stop order automatically closes a position as soon as price reverses and moves up by a set percentage or dollar amount. Conversely, it allows a trader to generate maximum profits on each sell position opened.

The sell order also does not put caps on profits. A trader would remain in the market as long as a sell position is moving in their favor moving lower. As long as prices are dipping, a trader would remain invested and generate optimum profits.

The order allows short Sellers take emotions out of their trades as the order automatically tracks profits and closes position as soon as price reverses.

Disadvantages

One of the biggest drawbacks of a trailing stop sell order is that an order may not fill in case price gaps higher. In this case, a position can accumulate too much of a loss than the predetermined dollar amount or percentage point.

Conclusion

A trailing stop sell order is a market order with a stop loss component that tracks price as it moves lower. The sell order only closes a position when price reverses and moves against a trader by a set percentage point or dollar amount.

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Created on Jun 7th 2020 22:44. Viewed 305 times.

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