Trailing Stop

A trailing stop is a stop-loss order that automatically adjusts with the market price to protect profits as a trade moves in your favor. It lets winning positions run while limiting downside if the market reverses.

Key takeaways

• Trailing stops protect gains by moving the stop price as the market moves in your favor.
• Balance is crucial: too tight a trail triggers premature exits; too wide a trail gives back profits.
• They work best in trending markets and help remove emotion from exit decisions.

How a trailing stop works

A trailing stop is set a fixed distance from the current market price — expressed as a percentage, dollar amount, or based on volatility. For a long position, the stop rises when the price rises but never falls when the price drops. When the market reverses and hits the stop level, the position is closed (typically via a market order).

Deciding the trail distance depends on:
* Time frame (day trade vs. swing vs. position)
* Market volatility
* Personal risk tolerance and strategy

Common methods for setting trailing stops

• Percentage trail — e.g., 10% below the market price.
• Fixed dollar trail — e.g., $5 below the current price.
• Volatility-based (ATR) — using Average True Range over n days to scale the stop with volatility.
• Moving average trigger — exit when price closes below a chosen moving average (e.g., 8-, 20-, 50-day).
• Support/resistance levels — place stops just beyond recent support or resistance to avoid normal pullbacks.

Example

You buy a stock at $100 with an initial stop at $95 (5%). The stock rises to $110 and you set a trailing stop of 10%:
* At $110 the trailing stop is $99 (10% below).
* If the stock reaches $135, the trailing stop becomes $121.50 (10% below).
* If price then falls below $121.50, the stop triggers and you exit, locking in the gain accrued up to that stop.

This approach secures gains while allowing the stock to climb, but the final outcome depends on the chosen trail distance.

Pros

• Locks in profits while allowing winners to run.
• Reduces emotional decision-making by defining exits in advance.
• Automates risk management on many trading platforms.
• Particularly useful for trend-following strategies.

Cons

• Requires understanding of market behavior and technical concepts.
• Not ideal for sideways or highly choppy markets — higher chance of being whipsawed.
• Can cause premature exits if the trail is set too tight relative to volatility.
• Less suited for certain time frames (e.g., many day-trading setups) unless adapted.

Bottom line

Trailing stops are an effective tool for protecting profits and managing risk, especially in trending markets. Their success depends on choosing an appropriate trailing distance and method that matches the asset’s volatility, the trader’s time frame, and the trading strategy.