Trailing Stop

A trailing stop is a type of stop-loss order used by traders to protect profits and limit losses in a trade as the market moves in their favour.

Unlike a regular stop loss, which remains at a fixed price, a trailing stop moves with the price as it fluctuates. Essentially, it "trails" the market price by a set amount (either in points, pips, or percentage), but it does not move backward.

If the market price moves in the direction favourable to the trade, the trailing stop moves with it to lock in profits. However, if the market price starts moving against the trade, the stop-loss order remains at the last level, potentially triggering an exit to prevent further loss.

Here is an example: trader buys a stock at $100 and set a trailing stop of $5. As the stock price increases to $110, the trailing stop will adjust to $105 (5 points below the current market price). If the price continues to rise to $120, the trailing stop moves up to $115.

However, if the price starts falling and hits $115, the trailing stop will trigger a sell order, locking in profits between $100 and $115, depending on how much the price has risen before the fall.

The main advantage of a trailing stop is that it protects profits. It allows traders to lock in profits without having to constantly monitor the market. It also helps in minimizing losses by securing an exit point when the price moves against the position.

However as a disadvantage, the trailing stop can be triggered too early. In volatile markets, it may be hit prematurely due to short-term price fluctuations, potentially closing a position before the trade has had a chance to fully develop.

It also requires precise settings. Setting the trailing stop too tight or too loose can impact how well it works in capturing profits while limiting risk.

Overall, trailing stops are an essential tool for traders who wish to automate their exit strategy while allowing profits to run in favourable market conditions.