Trailing Stop Orders

The least commonly used order types of the four, by far, is the trailing stop order. It is only used when you already hold shares of stock (active position) that is profitable and you want to lock in increased profits as the stock rises.

The whole point of a trailing stop order is to protect yourself on the downside, while continuing to give yourself room to profit on the upside.

The concept behind these orders is very simple. The order uses a set percentage or dollar $ value to calculate when to trigger a preset stop market order. The activation price automatically changes as the stock moves higher.

Example: You hold 100 shares of stock XYZ at $100, and the stock is currently trading at $110. You want to let the stock run higher, but don’t want to risk the stock falling back too far. To protect yourself but still give yourself room, you set a 5% trailing stop market order. So, at the time you place it, the activation price is $104.50 ($110 – 5%). As the stock moves higher, the price automatically adjusts, so at $111 the activation price is then $105.45 ($111 – 5%). Once the activation price hits and the order is triggered, a market order is simply placed automatically and your shares are sold.

While the activation price can RISE, is cannot FALL. Using the example above, once stock XYZ hits $111 a share, our trailing stop loss order is set at the new $105.45 price. It CANNOT go lower than that. As the stock rises, our activation price RISES; however, it doesn’t matter how fast the stock falls, our activation price will not adjust unless the stock sets a new price high.

Tip for success: It is important to give the stock enough room to move around naturally, as stocks don’t always JUST go up. For example, a 1% trailing stop order is far more likely to get triggered prematurely than a 5% trailing stop order.