Neither a magic wand nor a profit machine, trailing stop-loss is simply a trading feature that helps you liquidate your position when the market moves against you.
TradeSanta will be launching this order type in the near future. While waiting for the release, we thought it would make sense to consider trailing stop-loss in detail.
With trailing stop-loss, you don’t need to set your stop-loss manually each time a market trend changes in your favour. The order will only get executed when the trend moves against you.
What is trailing stop-loss?
Trailing stop-loss, or trailing-stop, is a type of trade order that gets executed once the price no longer moves in your favour, whether you use a short or long strategy. This type of order is designed to protect your gains while the trade is still open and continues to profit.
How trailing stop-loss works
Here is an example. Let’s say, you pursue a long strategy, meaning you buy coins at a lower price and then sell when the price goes up.
Crypto trailing stop loss example
In this scenario, you need to sell your asset before its price goes down. If you add a 10% trailing stop-loss to a long position, a sell order will be activated when the price drops by 10% from its latest peak after the purchase. So, unlike standard stop-loss, which is activated when the price drops 10% from the initial buy price, trailing stop-loss is recalculated from the latest peak price.
Correspondingly, once you place a 10% trailing stop-loss to a short strategy, a buy order will get triggered when the asset price crosses the 10-percent mark.
This order type might become somewhat risky in volatile markets. Strong coins regularly demonstrate abrupt falls and a low trailing distance might trigger liquidation of the asset before its price reaches higher levels.
So, before adjusting a trailing distance for every order, we recommend analyzing volatility levels and market trends for each asset individually.
If you want to learn more about the other advanced order type Trailing Take Profit, we’ve got this guide, too!
Real-Life Examples and Case Studies
Example 1: The Cautious Trader
A cautious trader, John bought shares of XYZ Company at $50 each. When he was concerned about potential market volatility, he set a stop loss at $45. When XYZ’s price fell to $45 due to market fluctuations, John’s stop-loss order was triggered, selling his shares and limiting his loss to $5 per share. This strategy saved John from further losses as XYZ’s price declined.
Case Study: The 2008 Financial Crisis
During the 2008 financial crisis, many investors suffered significant losses. However, those who had set stop-loss orders managed to limit their losses. For instance, an investor holding shares of a major bank might have set a stop loss at 10% below the purchase price. When the market plummeted, the stop-loss order was executed, selling the shares before the price fell further. This real-life scenario highlights the importance of stopping losses and protecting investments during market downturns.
Comparison with Other Advanced Order Types
Stop-loss orders are often compared with other advanced order types, such as limit, stop-limit, and trailing stop orders.
Stop Loss vs. Limit Orders:
- Stop Loss Order: This executes a market order when the asset reaches a specified price, ensuring the sale occurs but not guaranteeing the price.
- Limit Order: Specifies the exact price at which the trade should be executed, guaranteeing the price but not the execution.
Stop Loss vs. Stop-Limit Orders:
- Stop Loss Order: Converts to a market order at the trigger price, ensuring execution but not the price.
- Stop-Limit Order: This becomes a limit order at the trigger price, specifying the maximum or minimum price at which the trade will execute, which may result in the order not being filled if the price moves too quickly.
Stop Loss vs. Trailing Stop Orders:
- Stop Loss Order: Static and set at a specific price.
- Trailing Stop Order: This order moves with the market price, allowing for potential gains while still providing protection if the price reverses by a certain amount or percentage.
Tips on Setting Trailing Stop-Loss in Different Market Conditions
Bull Market:
In a rising market, use a trailing stop loss to protect profits. Set the trailing stop at a percentage or dollar amount below the market price. For instance, if a stock trends upwards, you might set a trailing stop 10% below the current price. This way, if the price rises, the trailing stop moves up, locking in gains.
Bear Market:
In a declining market, a trailing stop loss can help mitigate losses. Set the trailing stop tighter, perhaps at 5% below the market price. This ensures that if the market continues to fall, the position is sold quickly to minimize losses.
Volatile Market:
Adjust the trailing stop during high volatility to account for larger price swings. A wider trailing stop, such as 15% or 20%, prevents premature triggering due to normal market fluctuations, allowing you to stay in the trade longer.
Pros and Cons Analysis
Pros:
- Risk Management: Stop loss orders help manage risk by limiting potential losses.
- Discipline: They enforce a disciplined approach to trading, preventing emotional decision-making.
- Peace of Mind: Knowing that a stop loss is in place provides peace of mind, especially during volatile market conditions.
- Automated Execution: Orders are executed automatically without the need for constant monitoring.
Cons:
- Market Gaps: In highly volatile markets, prices may drop, causing the stop loss to execute at a much lower price than intended.
- False Signals: Market fluctuations might trigger the stop loss prematurely, resulting in missed opportunities if the price rebounds.
- Lack of Flexibility: Stop loss orders are rigid and do not account for changing market conditions or new information.
- Costs: Frequent triggering of stop-loss orders can lead to higher trading costs due to commissions and fees.
Conclusion
Stop loss orders are vital tools for traders and investors who aim to manage risk effectively. By understanding their real-life applications, comparing them with other order types, and knowing how to set trailing stop losses in various market conditions, you can better protect your investments. However, weighing the pros and cons ensures that stop-loss orders align with your overall trading strategy.
FAQ
What is a trailing stop-loss?
Trailing stop-loss, or trailing-stop, is a type of trade order that gets executed once the price no longer moves in your favour, whether you use a short or long strategy. This type of order is designed to protect your gains while the trade is still open and continues to profit.
What’s the difference between a stop loss and a trailing stop loss?
Unlike a standard stop-loss that is activated when the price drops or rises from the initial buy price, a trailing stop-loss is recalculated from the latest highest or lowest price.