Trailing Stop - An Effective Risk Management Tool for Traders

Core Issues in Trading

Every trader faces a difficult question: when should I take profit or cut losses? Sometimes you’ve gained a decent number of pips but fear the market will reverse. Conversely, when experiencing a losing trade, you hesitate whether to hold the position or close immediately. Both situations allow emotions to override reason, breaking the disciplined trading plan.

To address this, professional traders often use automation tools, including the Trailing Stop order—a highly effective strategy to minimize emotional influence.

What is a Trailing Stop and How Does It Work?

Trailing Stop is a special type of stop order that allows you to set a take profit or stop loss level based on a percentage or a fixed number of pips, and this level automatically adjusts with the market price.

Key features of a Trailing Stop:

• The price level only moves in a direction favorable to the trader
• When the price reverses beyond the set distance, the order automatically executes
• Helps protect existing profits while allowing for further gains

Detailed illustrative example

Case 1: Using a 10-pip Trailing Stop

You predict the USDJPY pair will rise and open a Long position at 107.852:

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

Market movement afterward:

• Next day: price rises 50 pips to 107.902, Trailing Stop automatically moves up to 107.892
• Day three: 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 moves up to 107.912
• Finally, when the price drops to 107.912, the order executes, and you take profit with 60 pips

Case 2: Using a percentage

If you enter a Short at 126.332 with a 10% Trailing Stop:

• Then, if the price increases by more than 10%, the order executes around 139.219
• In this case, the Trailing Stop functions like a regular Stop Loss order

Strategies for Setting an Appropriate Trailing Stop

The key is not to set it too tight or too wide:

Too tight: The order may be triggered by normal market fluctuations, causing you to exit too early before the trend fully develops.

Too wide: You risk losing significant profits or missing out on potential gains.

Since each asset and market cycle has different volatility, there is no one-size-fits-all formula. You need to:

• Analyze the specific market volatility
• Combine with your personal trading style
• Adjust according to your risk management strategy

Practical rules:

• Volatile markets → Wider Trailing Stops
• Stable markets → Closer to market price

6 Effective Methods to Use Trailing Stop

Method 1: Based on Acceptable Risk ®

Determine your maximum tolerable loss ®, then set the Trailing Stop at 1R, 2R, or nR:

• Highly volatile markets: set at 2R or more to avoid premature exit
• Stable markets: set at 1R to maximize profit protection

Method 2: Using Parabolic SAR

Parabolic SAR is a technical indicator that identifies when momentum is about to end. When a candle approaches the SAR, it signals a potential reversal:

• Set the Trailing Stop at the nearest SAR level
• Ensure to take profit before the price reverses

Method 3: Based on the high/low of the X candles before

Use the highest or lowest price of the previous X candles:

• Long position: Trailing Stop = lowest low of X candles
• Short position: Trailing Stop = highest high of X candles
• The number of candles can vary depending on your trading timeframe

Method 4: Based on support-resistance levels

A simple yet effective method:

• Identify key support and resistance lines
• Set Trailing Stops at these levels
• Suitable when unsure of exact peaks/troughs

Method 5: Bar Plus (Candles + additional pips)

Similar to method 3, but add a certain number of pips to the price level:

• Usually add 50% of the Average True Range (ATR)
• For example: if ATR = 60 pips, add 30 pips to the high/low of the candle

Method 6: Using Moving Averages

Allow the Trailing Stop to slide along with the Moving Average:

• Most common: SMA20 or EMA20
• For long-term trading: increase the period (SMA50, EMA100)
• For short-term trading: decrease the period (SMA10, EMA5)

Advantages and Disadvantages of Trailing Stop

Advantages

Unlimited profit potential: Unlike fixed limit orders, Trailing Stops allow you to capitalize on the entire upward trend. It moves with the price, helping you not to miss further gains.

Automation saves time: You don’t need to constantly monitor the market to adjust orders. Everything happens automatically based on market price.

Disadvantages

No guarantee of order execution: For assets with high volatility or low liquidity, the price may jump past the Trailing Stop level without executing.

Difficult in sideways markets: If the price moves sideways, the Trailing Stop may be triggered repeatedly, leading to unnecessary losses.

Loss of decision-making ability: Relying entirely on automation can cause you to miss deeper market analysis opportunities.

When to Use Trailing Stop?

Trailing Stop is most effective when:

• The market is trending strongly (trending market)
• You want to protect current profits but still allow for further gains
• You don’t have much time to monitor prices constantly

Avoid using when:

• The market is moving sideways (sideway), with no clear trend
• Volatility is too high, making it hard to determine a reasonable Trailing Stop level

Conclusion

Trailing Stop is a powerful tool to maximize profits and manage risks effectively. It not only helps protect your gains but also automatically pursues profits when the market is favorable. However, success does not come from the tool itself but from how you set it up.

The appropriate Trailing Stop level depends on:

• Your trading style (short-term or long-term)
• The volatility of the traded asset
• Your personal risk tolerance

By combining these methods with disciplined trading, you can optimize your trading performance and minimize the negative impact of emotions.