The trailing stop is a feature attached to stop-loss orders, where the stop (safety net) position is automatically moved to the trader’s advantage as the market moves to their advantage.
Mechanics of the trailing stop
The easiest way to understand trailing stops is usually with a few examples.
Trailing-Stop On New Positions
Suppose a trader buys EURUSD at 1.2500, setting their stop one-hundred pips below at 1.2400 along with a 50 pip trailing stop. The trail will be benchmarked from the moment the trailing stop is set at 50 pips. If the market moves up 50 pips the stop will move up 50 pips – from 1.2400 to 1.2450. The trailing stop will continue to move up in those 50 pip increments.
Trailing-Stops On Existing Positions
Often traders find tailing stops confusing as they change them while a position is open. How do t-stops work when they are set or reset mid-trade? The t-stop works just the same as with the new order example above. Suppose a trader changes their stop to 1.2400 with a trailing stop of 50 pips. The trail is benchmarked from the moment the trail is confirmed. Should the market move 50 pips to the trader’s advantage, then the stop will automatically move 50 pips to the trader’s advantage. And the trailing stop will continue to move up in those 50 pip increments.
Tracking Trailing Stops
Often to make tracking the progress of t-stops easy, brokers will provide a ‘countdown’ field that tells you how many pips the market needs to move to your advantage until the stop trails.
Basic Tenets of the Trailing Stop
The first and most basic rule of thumb to follow with trailing stops is in setting the stop and trail such that regular market noise does not execute it before the market moves to your advantage.
For example if the market oscillates in fifty pip bands before continuing the desired trend, very easily a 5-pip-trailing with a close stop-loss will drag the protective stop into that market noise and close the position out before it is ever able to latch onto the desired trend.
One Pip Trailing Stops
Some market makers offer t-stops with minimum trail values of 30 pips, 10 pips or even down to 1 pip, depending on individual policies. This minimum value is the smallest amount a trader can set the trail to. In the examples above we set the trail to 50 pips, some brokers allow minimum trails as little as 1 pip – here the stop-loss is moved to one’s advantage single pip by single pip, usually done at the expense of quality, or the risk of premature execution.