How and When to Use a Trailing Stop Order

A trailing stop order (or “trailing stop loss order”) is a stop loss order that sets the stop price at a fixed amount below the market price for long positions. For stock investors, the appeal of a trailing stop loss is that if the market price goes up, the stop loss order price increases in proportion to that change in price. On the other hand, if the market price drops, the trailing stop order price stays the same. Using a trailing stop order, the investor can specify a limit on the possible loss they will see, without limiting their potential gain. There is also a convenience factor for investors as there is not need to monitor stock prices and react to price drops; if the share price falls below its trailing stop loss price, a sell order is executed automatically.

A stop loss order (or “stop market order”) is used as a way to limit an investor’s potential loss on a stock or other security by incorporating a sell component if the share price reaches a specified level. In this way, stop loss order provide insurance to the investor as they can save them from huge losses. As a general rule, unless you plan to hold the stock for a long period of time, you should consider using a stop loss to build in an automated trigger and eliminate the emotion from your sell decisions.

While stop loss orders are used to protect investors from suffering large losses, the attached trailing mechanism in trailing stop orders enables investors to lock into stock gains by associating the stop loss to a fixed amount below market price. If the stock price has increased (and the investor has unrealized gains) the trailing stop will have risen accordingly. When and if the price changes direction, the investor will not lose out on all of those gains.

Sell Trailing Stop Order: Sets the stop price at a predetermined amount under the market price with an associated “trailing” amount.

Buy Trailing Stop Order: Typically used in declining markets, buy trailing stop orders mirror sell trailing stop orders

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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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