One of the biggest challenges in trading is knowing when to exit a winning position. Sell too early and you leave money on the table. Sell too late and you give back your profits. Trailing stop orders solve this problem by automatically adjusting your stop price as a stock moves in your favor. In this guide, we will explain how trailing stops work and how to use them effectively.
What is a Trailing Stop Order?
A trailing stop order is a dynamic stop order that automatically adjusts as the price moves in your favor. Instead of setting a fixed stop price, you set a trailing amount (either a dollar amount or percentage) below the highest price reached. If the stock reverses by that amount, the stop triggers and you sell.
The simple version: A trailing stop follows your stock price upward like a loyal dog. It stays a fixed distance behind. If the price drops by that distance, you automatically sell. The stop only moves up, never down.
How Trailing Stop Orders Work
Here is the step-by-step process:
- You set a trailing amount (for example, $5 or 5%)
- The stop price is calculated as the highest price minus the trailing amount
- As the stock rises, the stop price rises with it
- The stop price never decreases, even if the stock falls
- If the stock drops from its high by the trailing amount, the order triggers
- Once triggered, a market order executes at the best available price
Trailing Stop Example with Dollar Amount
Example: $10 Trailing Stop
You buy 100 shares of Google at $150. You set a trailing stop of $10.
- Day 1: Google at $150, stop price is $140 ($150 - $10)
- Day 2: Google rises to $160, stop moves to $150
- Day 3: Google rises to $175, stop moves to $165
- Day 4: Google drops to $170, stop stays at $165 (never moves down)
- Day 5: Google drops to $165, stop triggers, you sell at market price
Result: You bought at $150 and sold at approximately $165, capturing $15 per share profit ($1,500 total) while protecting yourself from further downside.
Trailing Stop Example with Percentage
Example: 10% Trailing Stop
You buy 100 shares of Amazon at $180. You set a trailing stop of 10%.
- Day 1: Amazon at $180, stop price is $162 (10% below $180)
- Week 2: Amazon rises to $200, stop moves to $180 (10% below $200)
- Week 3: Amazon rises to $220, stop moves to $198 (10% below $220)
- Week 4: Amazon drops to $198, stop triggers, you sell at market
Result: You bought at $180 and sold at approximately $198, capturing $18 per share profit ($1,800 total) despite giving back some gains from the $220 high.
Dollar Amount vs Percentage Trailing Stops
You can set trailing stops in two ways:
- Dollar amount: The stop stays a fixed dollar amount below the high (example: $5 trailing stop)
- Percentage: The stop stays a fixed percentage below the high (example: 10% trailing stop)
Percentage trailing stops are often preferred because they scale with the stock price. A $5 trailing stop makes sense for a $50 stock but would be too tight for a $500 stock.
When to Use Trailing Stop Orders
Trailing stops are ideal for these situations:
- Trending markets: When stocks are in clear uptrends, trailing stops let you ride the trend
- Protecting profits: Lock in gains without capping your upside
- Momentum trades: Stay in winning positions longer
- When you cannot watch the market: Automatic protection while you are away
- Removing emotions: Let the market decide when to exit, not your feelings
Advantages of Trailing Stop Orders
- Automatic adjustment: No need to manually move your stop as the stock rises
- Profit protection: Locks in gains while allowing for more upside
- Removes guesswork: You do not have to predict the exact top
- Discipline: Forces you to take profits instead of getting greedy
- Works while you sleep: Protection around the clock
Disadvantages and Risks
Trailing stops have limitations to consider:
- Whipsaws: Volatile stocks can trigger your stop and then continue higher
- No price guarantee: Like regular stops, execution price may differ from stop price
- Gap risk: Overnight gaps can result in selling far below your trailing stop
- Too tight stops: Setting the trailing amount too small leads to getting stopped out frequently
- Not ideal for choppy markets: Sideways, volatile markets will constantly trigger trailing stops
Common mistake: Setting trailing stops too tight. If you use a 2% trailing stop on a volatile stock that regularly swings 5% daily, you will get stopped out constantly. Match your trailing amount to the stock's normal volatility.
How to Choose Your Trailing Amount
Selecting the right trailing amount is crucial:
- Check Average True Range (ATR): Use 1.5x to 2x the ATR as your trailing amount
- Consider volatility: More volatile stocks need wider trailing amounts
- Look at daily swings: If a stock regularly moves 3% daily, use at least 5% trailing stop
- Use chart support: Set trailing amounts that give room above key support levels
Trailing Stop Strategies
- The momentum ride: Use a tight trailing stop (5-8%) on momentum stocks to capture quick moves
- The trend follower: Use a wider trailing stop (15-20%) on trending stocks to stay in longer moves
- The breakeven lock: Once a stock rises enough, tighten your trailing stop to at least break even
- The tiered approach: Start with a wider trailing stop and tighten it as profits grow
Tips for Using Trailing Stop Orders
- Match to volatility: Use wider stops for volatile stocks, tighter for stable ones
- Do not set and forget: Review your trailing stops regularly to ensure they still make sense
- Avoid round numbers: Many traders place stops at obvious levels like 10%, making them targets
- Consider trailing stop-limit: For more price control, some brokers offer trailing stop-limit orders
- Account for time frames: Day traders need tighter stops than swing traders
Track Your Trading Performance
Pro Trader Dashboard helps you analyze all your trades, including how your trailing stops performed. See your average gains, when you got stopped out, and optimize your trailing amounts.
Summary
Trailing stop orders are powerful tools for protecting profits while staying in winning trades. They automatically adjust upward as your stock price rises, ensuring you lock in gains without manually updating your stop. The key is choosing the right trailing amount that gives your trade room to breathe while still protecting your profits. Used correctly, trailing stops can help you capture more of a winning move while limiting downside risk.
Want to learn about other specialized order types? Check out our guide on fill or kill orders or learn about good til canceled orders.