Definition: A trailing stop is a dynamic order that moves up with new highs (long) or down with new lows (short) in the market so as to preserve some predetermined proportion of open trade profit.
The trailing stop is constructed in a manner that continuously advances a stop in the direction of a profitable market move during the life of the trade. A trailing stop to protect a long position will move up as the market advances. A short trailing stop protects a short position in a declining
market.
It is also central to the concept of the trailing stop that it does not retreat. In other words, once a new high or low has been established and a new higher or lower trailing stop has been calculated, it is never moved lower or higher if the market moves against the trade.
The ideal trailing stop preserves as much open trading profit as possible while at the same time providing enough breathing room to encompass the market volatility that is a part of all trades. The vast majority of trades do not go straight in one direction without pullback. Ideally, the trailing stop will allow for these natural pullbacks and exit when the main thrust of the trade is ended.
There are endless potential trailing stop variations. Let us look at examples of two relatively common types of trailing stops: dollar and volatility.
Definition: A trailing dollar profit stop is an order to exit a position and is set at a fixed dollar value above the most current low price (short) or below the most current high price (long).
A trailing volatility profit stop is an order to exit a position and is set at a point value based upon some measure of market volatility above the most current low price (short) or below the most current high price (long).
The key to a successful trailing stop is to find that price level in the life of a trade, which, if penetrated, tells us that the move captured by the profitable trade is over. Of course, there are many ways to do this and it is left to the strategist to find that style of trailing stop most organically
suitable to his strategy. |
| Trailing stop |
The Trailing Stop
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