What Is a Trailing Stock Loss?
A trailing stop loss is a type of order that enables the trader to set a maximum dollar amount or percentage drop from the high point of a running position. The order is designed to capture a higher exit price on a position (a long position) every time the price ticks higher. If the price moves in your favor, the 'trailing' aspect pushes the stop order higher. Once the security price does fall by the maximum $ or % specified, the position gets stopped-out.
Trailing stop loss orders are commonly used in day trading. Day traders move into and out of positions all day long, often holding each position for less than a day. The trailing stop loss enables them to lock-in profits as the security price moves in their favor, and prevents them from large losses if prices move against them.
Traders can set up a trailing stop loss across their entire portfolio if they choose to do so.
Tip: A trailing stop loss order level adjusts alongside stock price movements in the trader's favor, but it stays locked-in when the stock price is moving lower.
How a Trailing Stop Loss Works
Traders place a trailing stop loss order through a brokerage that supports the order type. As the price of the stock moves in their favor, the trailing stop loss order rises along with it, but it doesn't move if the price moves against the trader. If the stock falls to the price of the trailing stop loss order, a market order to exit the position will be triggered.
Trailing Stop-Loss Order Examples
Example in Dollars
For example, an investor buys a stock at $100 and sets a trailing stop loss order at $90. If the shares rise, the trailing stop loss will move upwards by the same amount, always setting itself $10 below the high price realized while the trade is on. So if the stock rises to $102, the trailing stop loss order rises to $92, and it keeps trailing the stock price as it rises.
If the stock climbs to $130, the trailing stop order will sit at $120, meaning that at this point a guaranteed profit of $20/share is locked-in as a result of the trailing stop loss. Even if the price reverses course and falls to $115, the trailing stop loss order remains at $110. If the stock drops to $110, the stop loss order is converted to a market order, and the position will likely be sold at around that price.
Example in Percentages
Trailing stop loss orders can also be set in percentage terms. If a stock is purchased at $100 with a trailing stop level of 10%, the stop loss level will initially stand at $90. If the stock rises to $130, the stop loss price will have risen to $117, or 10% below the highest price realized while the position is on.
It's important to remember that a stop loss level doesn't guarantee execution at that price. If a stop loss order stands at $100, but a major development causes the stock to suddenly drop from $110 to $95, the position might be closed at $95 or lower, despite the stop loss level.
Note: Trailing stop loss orders can also be used on Short positions, where the stop loss level represents a buy order and will decline in price if the stock drops.
Pros & Cons of a Trailing Stop Loss Order
Pros:
- Automatically moves the stop loss level without requiring a trader to reset it themselves. Traders can use trailing stops to ride trends that are in their favor, while exiting when a reversal sets in.
- Guarantee an exit from positions once the stop loss level is hit. Trailing stop loss orders can enable traders to remove emotions from their trade.
Cons:
- They provide no guarantee that traders will receive an execution price near their stop level if a stock price drops suddenly. As a result, it can be dicey to trade volatile stocks using stops, or trailing stops.
Brokerages That Offer Trailing Stop Loss
Some brokerages that offer trailing stop loss orders include:
- Fidelity
- Robinhood
- WeBull
- TD Ameritrade
Note: There are many more options than those presented above. Check with your specific brokerage to see if trailing stock loss orders are available.
How To Set a Trailing Stop Loss
To place a trailing stop loss, log into your chosen broker and, in the case of a long position:
- Buy shares at a particular price
- Then set a trailing amount or percentage to limit losses. To create the trailing amount, place a sell order and then choose "trail" under order type.
- Next, enter a dollar amount or percentage, however much you want the order to trail the market price.
When an investor is long a stock, a trailing stop loss reflects a sell order. When an investor holds a short position and expects a stock to fall, a trailing stop loss reflects a buy order.
Important: Stock prices can move suddenly, especially at market open if major news or earnings results were reported while markets were closed. A stock price can quickly move through a stop loss level, subjecting the investor to a worse exit price than the level that was set.
Trailing Stop Loss vs. Trailing Stop Limit
A trailing stop loss is similar to a trailing stop limit order, but there are some differences. Both stop orders are designed to limit losses, and both allow an investor to benefit from the trailing aspect, locking in a better exit price as a trade moves in the investor's favor.
The goal of a trailing stop limit order, and stop limit orders in general, is to ensure traders don't sell below a price they are comfortable with if the stock price falls suddenly. If a sell trade is not possible at or above the stop limit price, the trade will not be executed.
Some traders avoid using trailing stop limits because doing so would put them at risk of holding positions that are moving quickly against them. A trailing stop loss order is guaranteed to be executed if the security price reaches the stop loss level, even if the stock price rapidly declines even lower. A stop limit order is not executed if the price quickly falls below the stop limit level.
Consider a long position where the stock is trading at $110, there's a stop loss level of $100, and a stop limit level of $98. If the stock drops suddenly from $110 to $95, meaning that the price has dropped through the stop limit level, the position will not be closed. The trader will continue to be at risk of further declines in this stock. However, had there been no stop limit level, the position would have been closed at the best available price after the stop loss level was reached.
