Trailing Stop Loss: Risk Management Tool in Trading and 6 Practical Strategies

What Is Trailing Stop Loss? Why Do Traders Need It?

In the world of financial trading, managing emotions is the biggest challenge. You might be in a profitable position but worry that the market will reverse, or you are experiencing losses and unsure whether to close the position or wait for a recovery. Both situations lead to poor decisions driven by emotions, weakening your trading discipline.

Trailing Stop Loss is a powerful tool that automates position management, eliminating emotional interference. It is a special type of order that allows traders to set stop-loss or take-profit levels based on a percentage or fixed pip amount, automatically tracking and adjusting as market prices change.

Unlike a regular Stop Loss order (fixed price), the trailing stop loss continuously adjusts upward when the price moves in your favor but will activate immediately if the price reverses beyond the specified level. This mechanism allows you to maximize profits without limiting your gains.

How Trailing Stop Loss Works

###Illustrative Example 1: Trailing Stop Loss 10 Pips

Suppose the USDJPY pair is trading at 107.852, and you forecast the price will rise, opening a Long position:

• Entry point: 107.852
• Set trailing stop loss: 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 loss automatically moves up to 107.892 (107.902 - 10 pips).

A few days later, the price drops to 107.900 but the trailing stop loss remains at 107.892 (since the price hasn’t crossed this level). When the market hits a new high at 107.922, the trailing stop loss moves up again to 107.912.

Finally, when the price drops and hits 107.912, the order is triggered, and you take profit at a 60 pip gain.

###Illustrative Example 2: Trailing Stop Loss 10%

A trader predicts USDJPY will decline, entering a Short position at 126.332 with a trailing stop loss of 10%.

After entering the market, the price rises straight up to 139.219 (more than 10%), triggering the trailing stop loss immediately. In this case, the trailing stop loss functions like a traditional Stop Loss order.

Important note: For Long positions, the trailing stop loss is set below the current price. For Short positions, it is set above the current price.

6 Effective Strategies for Using Trailing Stop Loss

Strategy 1: Trailing Based on Acceptable Risk Level (Risk Management)

Determine your maximum tolerable loss (given as R), then set the trailing stop loss at 1R, 2R, or nR depending on market volatility:

• Highly volatile markets: Set trailing at 2R or more to avoid early stop-outs
• Less volatile markets: Set at 1R to maximize profits before trend reversal

Strategy 2: Using Parabolic SAR (PSAR)

The Parabolic SAR is a technical indicator that helps detect when momentum is exhausted. When candles approach the PSAR point, it signals a potential reversal. You can set the trailing stop loss at the nearest PSAR level to ensure you lock in profits before the market turns.

Strategy 3: Trailing Based on Previous Candle Highs and Lows

Use the highest and lowest points of previous candles (for example, 3 candles):

• For Short positions: Set trailing stop loss at the highest high of the last 3 candles
• For Long positions: Set at the lowest low of the last 3 candles

You can adjust the number of candles based on your short-term or long-term trading strategy.

Strategy 4: Trailing at Support and Resistance Levels

This is a simple yet effective strategy. Place the trailing stop loss at key support and resistance levels:

• If you’re unsure where the peaks and troughs are, rely on these levels
• Helps you hold the trade longer and maximize profits

Strategy 5: Bar Plus - New Candle Plus Additional Pip

Similar to strategy 3, but the trailing stop loss is set at the high/low of the latest candle plus a certain number of pips:

• Common method: Add 50% of the Average True Range (ATR) to the high/low
• Example: If ATR = 60 pips, add 30 pips to the previous candle’s high/low

Strategy 6: Trailing Based on Moving Average (Moving Average)

Set the trailing stop loss according to the Moving Average line, allowing the price to trail along with the MA:

• Popular choices: SMA20 or EMA20
• Adjust the period based on your needs: short-term or long-term

How to Determine the Optimal Trailing Stop Loss Level

The key to success is finding the right level—neither too tight nor too wide:

If too tight:

• Orders are triggered by normal market movements
• You get stopped out before the trade can move in your favor
• Leading to unnecessary losses

If too wide:

• Increased risk of large, unnecessary losses
• Potentially losing out on profits
• Similar to having no risk management plan

Adaptive principle:

• Highly volatile markets → wider trailing stop loss
• Less volatile markets → tighter trailing stop loss closer to current price
• Different markets (forex, crypto, indices) have different volatility profiles
• No one-size-fits-all formula—analyze and combine with your personal trading style

Advantages of Trailing Stop Loss

▶ Unlimited Profit Potential

You cannot predict how much the price will rise or fall. Using a fixed take-profit order (Limit Order) and closing early while the trend is still strong can lead to regret. Trailing stop loss allows you to maximize profits by adapting flexibly to market movements.

▶ Automation - Time Saving

No need to constantly monitor prices or manually adjust orders. The system manages your positions automatically, giving you time for other tasks or trading multiple pairs simultaneously.

Disadvantages of Trailing Stop Loss

▶ Order Mismatch Risk

When prices move rapidly, especially with less liquid assets, orders may not execute at the calculated trailing stop level.

▶ Difficult to Use with Highly Volatile Assets

If you set the level too low relative to volatility, the chances of order mismatch increase significantly. Balance between protecting profits and feasibility is necessary.

▶ Dependence on Automation

Relying too much on automated systems can impair your ability to make decisions based on analysis, or to think about optimal buy/sell timing. Combining automation with analytical skills is essential for optimal results.

When Should You Use Trailing Stop Loss?

• In strong trending markets: Trailing stop loss works best when prices clearly move in one direction
• To protect accumulated profits: Set it as soon as you are in profit
• When you lack time to monitor: Automated tools keep you safe when you cannot constantly watch the chart

Avoid using:

• When the market is sideways (ranging), as it will be repeatedly stopped out by sideways volatility

Conclusion

Trailing stop loss is a powerful tool to maximize profits and minimize losses in trading. If you lack time for daily technical analysis, this tool helps save time while ensuring your trades remain profitable at the highest levels.

However, there is no universal trailing stop loss setting suitable for everyone. It depends on:

• Your trading style (short/long-term)
• Market volatility
• Personal risk tolerance
• The asset you are trading

Combine these strategies with your own technical analysis skills, and you will find the most effective way to use trailing stop loss for your trading style.