Trailing Stop Loss Strategies: 3 Techniques to Try
How to set a trailing stop loss to maximise gains.
You’ve basically got two choices when it comes to placing a stop loss.
1. Set a fixed stop away from the current price. Usually behind a key level or a multiple of the ATR.
2. Use a trailing stop loss that either manually or automatically moves as the trade goes in your favour. Locking in more profit as it goes.
There are pros and cons to both and you need to select the right tool for the job…
But a trailing stop loss strategy is a key skill for a trader to learn, so lets explore 3 of the best trailing stop loss strategies to limit your downside risk whilst locking in profits along the way.
Table of Contents
What Is A Trailing Stop Loss Order?
We need to first define a traditional stop loss before learning about the trailing stop technique.
A stop loss (or stop) is an order that automatically closes a losing position at a preset market price.
It’s a simple yet necessary tool for managing risk, keeping losses consistent, and preventing margin calls.
Meanwhile, a trailing stop loss is designed to automatically lock in profits after predetermined levels.
It’s worth noting that a stop loss is first a fixed or traditional stop before it becomes a trailing one. This happens once your trade starts to move in your direction.
You can automatically secure gains at set levels as the market moves favourably.
In doing so, we may consider the trailing stop loss somewhat of a passive risk management strategy.
Of course, it’s more complex than this.
The point is that you can lock in profits automatically, which wouldn’t be possible with a regular stop.
Most trading platforms offer you an option to add a trailing stop before and after executing a position in the markets.
These behave differently depenidng on the platform. Some offer a ‘stair step’ function, moving up at certain intervals, others will move up with each tick the trade goes in your favour.
You can also move the stop manually, dragging it up (for longs) or down (for shorts) at certain time or price intervals.
The best way to do this operationally is to move the stop at certain price points as the trade goes in your favour.
eg: If price moves 35 ticks in your favour you drag the stop up, another 35 ticks… you move it again. You only move it once the trade has moved that pre determined amount.
How Do Trailing Stop Losses Work?
Like everything in trading right, you need to have a plan…It’s best to always have a specific trailing stop loss strategy where you determine at which point your stop loss should begin moving.
You don’t want to be making these decisions on the fly.
Many traders prefer to add this order before placing their trades.
Let’s use forex examples going forward.
In this case, you would decide the number of pips your stop should trail according as the price moves in your direction.
For instance, assume you want to use a trailing stop after 30 pips. And you are moving this manually.
In this case you would start the trail once the market has moved 30 pips in profits away from the current market price.
At this point, the trader is technically at ‘breakeven,’ or their trailing stop loss is precisely at their entry price.
If the market moved another 30 pips in the trader’s favour, the trailing stop loss would also jump the same fixed distance.
This means you would have secured 30 pips in profits while your floating profits are at 60 pips.
Let’s imagine that the market began retracing.
Your order would only get closed once the price drops to the level where you’ve secured 30 pips in profits.
In the initial example where the trader is at breakeven, the trading platform would close the position at this point if the market reverted. Your stop loss would be triggered.
Trailing Stop Loss Example
Let’s look at how a trailing stop loss works on a real chart, the 4HR time-frame of GBP/CAD below.
Suppose a trader entered at 1.67786, with a 50-pip stop loss at 1.67286.
When the market rises 50 pips from the entry to 1.67786, the trailing stop gets moved from their stop to entry at 1.67786. Note how that stop loss moves 50 pips behind at every new 50 pip jump in price.
Eventually, the market retraces by more than 50 pips, kicking the trader out at 1.69786, securing a profit of 200 pips.
Advantages of Using A Trailing Stop
Trailing stops offer many benefits.
Automation
You can automatically preserve profits without actively using your computer or phone. A traditional stop requires manual intervention to lock in profits. You’d set the automatic trailing stop and let the market take you out of the position.
We know that market volatility isn’t always your friend. In some situations, the price quickly goes against your position, and you may not have enough time to manually move your stop loss to a profitable area. This is where a trailing stop loss can be highly beneficial.
The next motivation to use a trailing stop is to save time and effort. This is especially practical for traders who trade frequently, such as scalpers and day traders. These traders find it difficult to micro-manage many individual positions using regular stops.
Meanwhile, a trailing stop can reduce the time and effort needed for trade management. A gap in seconds and minutes makes a world of difference, particularly in highly volatile markets. So, the automatic nature of the trailing stop loss order is the solution.
Trading Psychology and Discipline
Finally, trailing stops take the emotion out of managing trades. Most traders, even the experienced ones, are susceptible to common mistakes when it comes to securing gains, like closing their trades too early or fiddling with their stop loss.
On the other hand, a trailing stop (assuming you don’t interfere with the order!) is a more hands-off, emotionless approach.
Disadvantages of Using A Trailing Stop
Most traders are familiar with the age-old adage, “Cut your losses early and let your profits run.” Sadly, trailing stops aren’t always the best way to reap maximum gains, especially for long-term traders.
There is no exact science to choosing the most optimal fixed distance to keep your orders open in market conditions with fluctuations.
This is why a common problem with trailing stops is that traders set them too close to the price.
We know that the market often moves in a step-like manner rather than a straight line.
Sure, we may witness moments in highly trending markets where the price moves in a parabolic fashion.
So, a trailing stop may close your order at a less-than-optimal level, kicking you out of what would turn out to be a massive price movement.
Let’s consider a real-life example to demonstrate the downside of using a trailing stop loss order.
Here, we have the 1HR chart of NZD/USD.
Lets pretend you entered at 62.150 and chose a trailing stop loss of 15 pips (with your ordinary stop loss at 62.300).
Once the market moved to 62.000, your trailing stop loss would go to your entry at 62.150
Once the market moved to 61.850, your trailing stop loss would be at 62.000
Note the orange-highlighted area to show the retracements.
Your trailing stop would have triggered at 62.000. However, the market eventually dropped much further (over 100 pips).
So, while the trailing stop secures profit, it is less flexible than a regular stop loss.
Popular Trailing Stop-Loss Strategies
Moving Average Trailing Stop Loss Strategy
The first strategy involves moving averages (MA), the cornerstone of technical analysis.
Many traders use an exponential MA, mainly with 20, 50 and 100 periods. 20 for short-term traders (scalpers, day traders), 50 for medium-term or swing traders, and 100 for long-term or position traders.
The idea is to trail your stop on the moving average as it updates over time. In other words, it should be in line with the indicator, shifted up or down accordingly.
This stop loss will be triggered once the market exceeds the MA, suggesting that the trend has changed direction and is likely to move against your position.
Let’s look at two examples.
The image above shows the euro’s 1HR chart.
We have an entry at 1.09250 and are using the 20-day exponential moving average. Note the moment when the price dips below the MA and trends lower.
I have used a highlighted slanted rectangle on the MA to show the path of the trailing stop. This would have happened until the price reversed at the orange ellipse (hitting the MA and trailing stop loss) around the 1.08200 area, meaning a trader could have secured around 105 pips.
Our last example is on the 30-minute chart of GBP/JPY.
We have an entry at 179.300 at the callout label using the same 20-day exponential MA.
Soon after, this long position showed promise by moving above the moving average until it reverted to the MA around 181.200.
This would have been your exit.
Average True Range Trailing Stop Strategy
Next up is capitalising on the Average True Range indicator as a trailing stop loss strategy.
The ATR is a non-directional indicator that measures volatility, a key concept when we talk about stop losses.
It helps to show the average range (let’s go with pips as with the other examples) a market has moved within a certain period.
The idea is to have your stop above the range, decreasing your chances of your trade being closed prematurely.
However, traders have created a specific ATR trailing stop indicator with a chart overlay based on specific ATR settings.
The slight drawback is that this ATR indicator is a modified tool, meaning it will take much trial and error to find the best one.
Either way, many of these indicators should have a moving average period and a multiplier.
The former determines how far the trailing stop is from the current price. The higher the multiplier, the wider the trailing stop is, and vice versa.
Most traders like to use 2 or 3.
As with the moving averages, the ATR trailing stop traces where you should move your stop accordingly. It looks similar to the Parabolic SAR indicator, another volatility tool.
The ATR trailing stop I’m using is from Sylvian Vervoort on TradingView. The first is a buy position on the hourly chart of gold.
The next example is a short position on the daily chart of GBP/CHF.
Support And Resistance Trailing Stop Strategy
Some prefer a strategy to trail their stop loss without indicators.
This is where good ol’ support and resistance can work. Using this technique also requires some understanding of price action.
Firstly, this method is highly discretionary.
Also, it requires more patience to find sensible support and resistance levels for trailing.
While it means you spend more time on a trade, there is also the risk of getting kicked out with less profit than desired.
So, you may use another strategy in these situations.
It’s also crucial to have an ultimate exit strategy in mind where you eventually close your order based on the holding time, risk-to-reward parameters, etc.
In my experience, a good support or resistance area is where multiple candles with noticeable tails or wicks occur before the market makes a new high or low.
Sometimes, a large candle brings a new low or high after a short-lived swing high/low. Let’s look at an example on the 4HR chart of NZD/JPY.
Assume you entered at 93.100 for this sell position.
The first ellipse marks the first resistance level where you would have moved your stop loss.
However, note the gap as the price fell substantially, giving no swing highs/lows. This is what I alluded to earlier about moments where your stop is far from the current price.
Either way, the third ellipse marks the next resistance point you could have trailed your stop since this preceded a new low. The same goes for the other points until the price reversed to the resistance area around 91.216.
Finally, we have the daily silver chart with an entry at the 18.27500 price.
I have marked the support and resistance points.
As with the last example, there are some parts where your stop would have been far from the current price (e.g., between the first and second ellipse).
With this trade, the market would have hit your trailing stop around the 23.45 area.
Conclusion
As with anything related to technical analysis, using trailing stops is more art than science.
Every trader dreams of capturing the maximum profit from a trade. But no trade will be perfect, and it doesn’t need to be…
No one wants to leave a lot of profit on the table in the hopes of a bigger move that may never materialise.
Everything boils down to your trading plan and risk-to-reward parameters, whether using an automated trailing stop or a manual trailing stop strategy.
Find that perfect balance between maximising your gains and closing your positions too early.
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