Secret Trading Tip #15 : Trailing Stops

The topic of trailing stops comes up on occasion in my Virtual Trading Room. They can often cause some confusion, so let’s take a bit of time to clarify what constitutes a trailing stop and how you can use it in futures trading..

Trailing stops are actually stop loss orders that you move according to certain parameters in your trading plan.

Why Move Stop Loss Orders?

Stop loss orders are stop orders that are placed at levels where you would exit the trade. That exit point could be based on risk tolerance levels, moving averages, or key technical levels in the market. However you select your stop loss price point, it is usually in a place where the market is moving against an open position.

That point can become obsolete or change when the market is moving in favor of your open position. That means that there can be market movement that would necessitate a re-evaluation or move for your stop loss.

Look at it this way:

If you have a long e-mini S&P 500 position open, your stop loss would be below current market value. Let’s say that when you put the position on, you based your stop loss placement on a point value below entry. Using the Trading Advantage method, the stop should be no more than 3 points away. If the market moves higher, your stop loss would be further from the current price, and it might make sense to move it higher, perhaps to your breakeven level or even up to 3 points below current market price levels. If the market continues to move higher, your stop loss could be re-adjusted higher to keep it within those 3 points.

In this way, you have the chance to try to lock in unrealized gains on an open position. Prices can still gap through your stop price level, so it isn’t a perfect guarantee, but it does provide a level of emotional insurance, and they are another handy tool to use.

Does it cost money to keep replacing an order?

No. Stop loss orders are just instructions for an action to take if a market reaches a certain level. You can cancel and replace them as many times as you want or need to. Commissions and fees are only charged for executed transactions.

The trick to trailing stops is to make sure that you are cancelling and replacing the stop loss order every time and not accidentally placing a new order.

Trailing stop loss example:
[You must be registered and logged in to see this image.]

*PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.
Chart courtesy of Gecko Software.

One type of trailing stop we use in the Virtual Trading Room is the momentum stop, which is a little more advanced. This trailing stop is automatically calculated by an algorithm in our trading software that measures the velocity of the market as well as the average true range of each bar. Once each bar closes, the algorithm instantly calculates a new trailing stop that helps us both protect unrealized profits and try to protect our equity if the trade results in a loss.

Whichever trailing stop placement method you choose doesn't really matter because all of them will allow your decision making to be potentially free from emotional influences. You are keeping your exit fluid, moving it as market forces move prices.

Larry Levin
President & Founder - [You must be registered and logged in to see this link.]