What is Trailing Stop? A Detailed Guide to Risk Management Tools in Trading

Emotional Issues in Trading Decisions

One of the biggest challenges traders face is managing emotions when executing trades. You might be holding a profitable position but fear the market will reverse, causing you to lose gains. Conversely, when a position is losing, you hesitate between cutting losses immediately or holding on in hopes of a recovery. Such situations often lead to irrational decisions, undermining your initial trading plan. Fortunately, modern technical tools like Trailing Stop can help eliminate this emotional factor, allowing traders to execute strategies automatically and with discipline.

What Is a Trailing Stop?

A Trailing Stop (trailing stop order) is a special risk management order that automatically adjusts your take-profit or stop-loss levels based on market price fluctuations. Instead of setting a fixed price, this order “trails” the current price of the asset, maintaining a fixed distance (measured in pips or percentage).

How Trailing Stops Work

When you open a Long (predicting price increase) position, the Trailing Stop is set below the current price. If the price continues to rise, the Trailing Stop level automatically increases accordingly, but it only moves in one direction—always protecting profits. When the price drops below the specified Trailing Stop threshold, the order is triggered, and the position is closed.

For a Short (predicting price decrease) position, the principle is similar but the Trailing Stop is set above the current price.

Real-Life Example of Trailing Stop

Example 1: 10 Pips Trailing Stop

Suppose the USDJPY currency pair is trading at 107.852. You expect the price to rise and enter a Long position with parameters:

• Entry price: 107.852
• Trailing Stop: 10 pips, meaning the initial trigger level is 107.842

The next day, the price increases by 50 pips to 107.902. The Trailing Stop level automatically moves up to 107.892. On the third day, the price drops to 107.900, but the Trailing Stop remains at 107.892.

When the market hits a new high at 107.922, the Trailing Stop automatically rises to 107.912. Finally, when the price drops to 107.912, the order is triggered, and you take profit with a 60 pip gain.

Example 2: 10% Trailing Stop

An investor predicts USDJPY will decline and enters a Short position at 126.332 with a 10% Trailing Stop.

After entering the market, the price rises straight up to 139.219—exceeding 10%. The stop-loss order is triggered. In this case, the Trailing Stop functions exactly like a traditional Stop Loss order, activated at 10%.

Advantages of Trailing Stop

Unlimited Profit Potential

Unlike a Limit Order (fixed take-profit level), Trailing Stop allows profits to continue growing as long as the price moves in your favor. You avoid prematurely taking profits when the trend is still strong.

Automation Saves Time

The trailing level adjusts entirely automatically, so you don’t need to update the order frequently. This is especially useful if you don’t have time to monitor the market constantly.

Effective Profit Protection

When the market begins to reverse, the order quickly triggers, helping you lock in profits before losses accumulate too large.

Disadvantages of Trailing Stop

Slippage Risk

On assets with low liquidity, prices can move too quickly, causing the order not to be filled at the specified Trailing Stop level.

Difficult in Highly Volatile Markets

If you set the Trailing Stop too close to the current price in a highly volatile market, normal market movements may trigger the order, causing you to exit too early.

Loss of Active Analysis

Relying entirely on automation may cause you to lose the ability to make decisions based on actual technical analysis.

Six Trading Strategies with Trailing Stop

Strategy 1: Trailing Based on Risk Tolerance

Determine your maximum tolerable loss ®, then set the Trailing Stop at levels of 1R, 2R, or higher depending on market volatility:

• Highly volatile markets: set Trailing Stop at 2R or higher to avoid premature exits
• Less volatile markets: set at 1R to maximize profits

Strategy 2: Using Parabolic SAR

Parabolic SAR is a technical indicator that identifies when momentum is waning. When the candlestick approaches the SAR dots, it signals a potential reversal. You can set the Trailing Stop at the nearest SAR point to ensure profit-taking before the reversal occurs.

Strategy 3: Trailing at the Highest/Lowest of X Candles

Use the highest or lowest price of previous candles:

• Short position: set Trailing Stop at the highest high of the last X candles
• Long position: set Trailing Stop at the lowest low of the last X candles

Adjust the number of candles (3, 5, 10…) based on your desired trade duration.

Strategy 4: Trailing at Support-Resistance Levels

A simple yet effective strategy. Draw support and resistance lines, then place Trailing Stops at these levels. These are points where the market tends to react, increasing the likelihood that the order will be triggered appropriately.

Strategy 5: Trailing at Bar Plus Levels

Similar to the X candles strategy, but the Trailing Stop is set at the high of each new candle plus a certain number of pips. A common approach is adding 50% of the Average True Range (ATR):

• If ATR = 60 pips, add 30 pips to the high/low of the previous candle

Strategy 6: Trailing Along Moving Average

Set the Trailing Stop along a moving average line, allowing the exit level to trail the trend:

• Popular choices include SMA20 or EMA20
• For longer-term trades, consider longer periods like SMA50 or EMA100

How to Set an Effective Trailing Stop

There is no “best” formula for all cases. The Trailing Stop level needs to balance between two extremes:

• Too tight: Orders are triggered by normal market movements, causing premature exits
• Too wide: You risk large losses or missing out on potential gains

Traders should:

1. Analyze market volatility
2. Consider their own experience and trading style (short-term vs long-term)
3. Test on a demo account before applying live

When to Use a Trailing Stop?

Maximum benefits when:

• The market is in a strong trend (uptrend or downtrend clearly)
• You want to protect profits while allowing further gains
• You don’t have time to monitor the market constantly

Avoid using when:

• The market is sideways (moving horizontally, no clear trend)
• High volatility may trigger false orders

Conclusion

A Trailing Stop is a powerful risk management tool that helps traders maximize profits while automating the stop-loss process. It removes emotional factors, allowing trades to continue trending positively and protecting you from significant losses.

Successful use of Trailing Stop depends on choosing the right level—neither too tight nor too wide—and combining it with other technical indicators like Parabolic SAR, Moving Averages, or ATR. By experimenting across different market conditions, you will find the strategy that best fits your trading style.