Money and Risk management

Trailing Stop

Having a long position and a price that is moving up after opening the trade, a trailing stop will track the price up-move signaling if price is falling back more than an allowed value. After a sufficient up-move, the trailing stop will prevent all of the profit from being lost.

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The initial stop will always remain the ultimate warning for closing the trade.

Figure 10.8: Buying signal when the closing breaks above the last descending trend line.

In the chart of figure 10.8, we have a buying signal when the closing price breaks above the last descending trend line.

With an initial stop at $10.0 or about 9% below the buying price, we are just below the last lowest turning point.

Choosing a trailing stop value is contingent on the desired outcome of the trade. Are you a short-term swing trader, or do you like to catch the bigger moves on the medium- to longer-term trends?

Figure 10.9: Small trailing stop broken.

Let’s first have a look at the short-term trend. Looking at the average daily price movement for this stock, it looks like we have to allow price reactions in the order of 7%. We, therefore, keep for our shorter-term example, a trailing stop of 7%.

On June 21 (figure 10.9), this trailing stop is broken; the position can be closed with a small profit.

Trying to catch bigger moves, usually related to longer time periods, will require you to use a bigger trailing stop percentage; this will allow bigger intermediate price reactions to keep you in the trade over those longer time periods.

Looking at the past volatility of this stock, 12% seems to be a good choice as a medium to longer term trailing stop.

Figure 10.10: Longer term bigger stop broken.

Apparently, the up-move in June was just a shorter-term reaction in a longer-term down-move, as we can see in figure 10.10.

On July 8, the closing price falls through the 12% trailing stop. We close the position with a small loss.

Again, it is clear that not executing a stop may be bad and subsequently leave you with very big losses.

Figure 10.11: Trailing stop performing well in medium term uptrend.

In figure 10.11, we see that in a medium-term uptrend, the trailing stop will do a good job as a last warning signal to take profit before losing any more profits, while it keeps us in the trade for the kind of price moves and time period we want to trade in.

You must always use an initial stop and a trailing stop as a last warning signal to close a position.

Remember you can also use the ATR based trailing stop previously presented.

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