Stop Loss Strategy: Trailing Stop Limits & Orders Explained

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Updated: 01 July 2020

You may be wondering where to place your trailing stop loss order when trading the financial markets. The right trailing stop will keep you in a trade for the duration of the trend and will take you out when the trend is exhausted. It will protect you from closing a trade too soon, or too late.

We will cover the following in this article

  • What is a trailing stop limit?
  • How does a trailing stop loss order work?
  • What is a good trailing stop loss percentage?
  • Should you use a trailing stop loss?
  • What’s a trailing stop limit?
  • What is the difference between a stop limit and a trailing stop limit?

Ready? Let’s get started

What is a Trailing Stop Loss Order?

A trailing stop is a stop loss order that tracks the price of the asset you are trading and is automatically adjusted. The trailing stop is different from the traditional stop loss order as it moves in line with the asset’s price, hence, securing your profits.

Stop Loss Order vs Trailing Stop Loss Order

The main difference between a stop loss order and a trailing stop loss is that a traditional stop is fixed, while a trailing stop moves with the asset’s price. The trailing stop also locks in your profit once the price moves in your favour, unlike the normal stop loss, which remains fixed below or above your entry price, at all times.

How Does a Trailing Stop Loss Order Work?

A trailing stop loss is usually set a fixed distance away from the current market price and moves in line with the price. If the trailing stop is placed on a buy trade, it will rise as the price rises while maintaining the set distance. However, the trailing stop loss will not move if the price reverses closing your trade.

Trailing Stop Loss Order Example

Let’s say we opened a buy trade on the EUR/USD currency pair trading at 1.1200 and had a 15 point trailing stop on our position. The trailing stop would be positioned at 1.1185 at the start but would keep rising with the currency pair’s price.

Over the course of the day, the EUR/USD currency pair rallied to a high of 1.1300 giving us an open profit of 100 pips with our trailing stop at 1.1285. The next day, we have negative news from the eurozone triggering a selloff in the pair to a low of 1.1250.

However, our trade will be closed at 1.1285 as this is where the trailing stop was positioned protecting much of our open profits.

How to Set a Trailing Stop on MT4

You can set a trailing stop on MT4 by following the five steps below.

  1. Open the MT4 platform and open a trade on your chosen instrument with a normal stop loss order.
  2. Click Ctrl+T to open the MT4 terminal, which pops up at the bottom.
  3. Locate the position in the trade tab and right-click on it to reveal the dropdown menu.
  4. Click on the trailing stop option and set your preferred stop distance starting at 15 points.
  5. That’s it, you should have a trailing stop on your position now.

How to Set a Trailing Stop on MT4

How to Set a Trailing Stop Limit

Let’s take a look at how to set a trailing stop at UK spread betting provider IG Group.

  1. Open the order ticket for your chosen instrument. In this example, we’re going to use the GBP/CHF currency pair.
  2. You’ll see a provision for the trailing stop under the deal tab where you can select the trailing stop option.How to Set a Trailing Stop Limit
  3. Input the trailing stop distance and the trailing step, and limit values to setup your trailing stop limit order.

What Is a Good Trailing Stop Loss Percentage?

What Is a Good Trailing Stop Loss Percentage?

Most traders use a trailing stop loss percentage of either 15% or 20%,  which works most of the time for stocks. Another way to determine a trailing stop loss distance is to use the stocks average volatility as a guide.

However, a 15% move in a currency pair is almost impossible as most currencies move about 0.5% – 2.0% daily. Therefore, the best way to set a trailing stop on a currency pair is to use pip values also known as points with most traders preferring to use 15-20 points (pips).

Trailing Stop Limits

What Is A Trailing Stop Limit?

A trailing stop limit is an order that allows traders to set a limit to their losses while allowing them to reap maximum profits from their trades. A trailing stop limit moves with the price when the market is moving in your favour, hence, locking in your gains.

How Does A Trailing Stop Limit Order Work?

The trailing stop limit order works by continually moving in line with the price if it is going in your chosen direction. However, the trailing stop limit remains fixed if the price reverses and starts moving in the opposite direction. You will be taken out of the trade once the price hits the trailing stop limit order.

Trailing Stop Loss vs Trailing Stop Limit

A trailing stop loss order is a market order that instructs your broker to close the trade once price hits the specified level. However, a trailing stop limit order instructs the broker to close your position at the specified price, or at a better price. A trailing stop limit ensures that you get the price you requested or better unlike a trailing stop loss order, which could be filled at a worse price than expected.

So, we now have an understanding of:

  • What a trailing stop loss order is
  • How to set one
  • What a stop limit is
  • The difference between a stop loss and a trailing stop loss order

With this in mind, let’s move on to potential trailing stop loss strategies to deploy.

Average True Range (ATR)

The ATR trailing stop strategy is one of the most popular trailing stop strategies among traders. The strategy’s popularity is based on the fact that it is based on an asset’s current volatility, hence, it is an accurate reflection of the price action.

Most traders use the 3 ATR values as their preferred trailing stop limit since it gives trades a sufficient distance to run. Let’s compare the different ATR values and how they respond to price changes.

1 ATR trailing stop limit

1 ATR trailing stop limit

You can see that you would have been stopped out of the trade very early and missed out on the rest of the trend.

2 ATR trailing stop limit

2 ATR trailing stop limit

The 2 ATR trailing stop distance is much better and would have kept you in the trade for much longer.

3 ATR trailing stop loss distance

3 ATR trailing stop loss distance

While the 3 ATR trailing stop loss limit is much better but it would not have been enough to keep you in the trade for the entire duration of the trend.

3.5 ATR stop loss distance

ATR stop loss distance

In this trade, a trailing stop loss distance of 3.5 ATR values would have kept you in the trade for much longer leading to you reaping the maximum profits on the trade.

From the above charts, it is clear that the wider trailing stop loss distance could have kept you in the trade for longer as opposed to the smaller ATR multiples.

Advantages

The main advantage associated with the ATR trailing stop is that it moves with the price and can locks in profits on open trades. It works well when automated as it can work independently even when you are not monitoring your trades.

For example, you can use the ATR values on the hourly chart if you want to hold the trade intra-day or for a few days at most. You can switch to the ATR values on the daily chart if you plan to hold your trades for several days at the least extending into a week or more.

Moving Average (MA)

You can also use the moving average indicator as a trailing stop given that it tracks the price of an asset very smoothly. The MA works in much the same way as the ATR indicator but you cannot have multiple of the MA as is the case with the ATR.

Most traders use the 20-period moving average or exponential moving average (EMA) to ride a trend up to exhaustion. Therefore, you can use the same setting to stay in a trending trade up until the trend is exhausted and the MA takes you out of the trade.

Automating Your Trailing Stops

You can see that the Ma trailing stop above would have kept you in the bullish trend on Alibaba stock, which started on October 24, 2019, and lasted for three months up to January 27, 2020.

Automating Your Trailing Stops

You can automate your trailing stop loss orders and limit orders by using Expert Advisors made to track changes in the ATR, the MA and any other indicator you choose.

Disadvantages

The main advantage associated with the ATR and MA trailing stop loss indicators is that a spike in the price may cause them to be triggered, kicking you out of the trade. You could be taken out of a trade prematurely due to the spike since the ATR and MA are lagging indicators, hence, will not react immediately to the sudden price change.

Final Thoughts

Using a trailing stop loss order in your trading is an excellent way to ensure that you reap the maximum profits from a trend while protecting your gains. The fact that a trailing stop loss order moves when the price moves in your favour while remaining fixed when the price reverses virtually eliminates the chances of having a profitable trade turn into a loser.