In the today's article, we will discuss a trailing stop loss. I will explain to you its concept in simple words and share real market examples.
🛑Trailing stop loss is a risk management tool that allows to protect unrealized profits of an active trading position as long as the price moves in the desired direction.
Traditionally, traders trade with fixed stop loss and take profit. Following such an approach, one knows exactly the level where the trade will be closed in a profit and the level where it will be closed in a loss.
Take a look at a long trade on USDCAD above.
The trade has fixed TP Level - 1.354 and fixed SL Level - 1.341.
Once one of these levels is reached, the trade will be closed.
Even though the majority of the traders stick to fixed sl and tp, there is one important disadvantage of such an approach – substantial gains could be easily missed.
After the market reached TP in USDCAD trade, the price temporarily dropped, then a strong bullish rally initiated and the price went way above the Take Profit level. Potential gains with that long position could be much bigger.
Trailing stop solves that issue.
With a trailing stop loss, the trader usually opens the trade with Stop Loss and WITHOUT Take Profit.
Take a look at a long trade on USDCHF.
Trader expects growth, he opens a long position and sets stop loss – 0.8924, while take profit level is not determined.
With a trailing stop loss, the trader usually opens the trade with Stop Loss and WITHOUT Take Profit.
As the market starts growing, one decides not to close the trade in profit, but modify stop loss – trail it to the level above the entry.
As the market keeps rallying, one TRAILS a stop loss in the direction of the market, protecting the unrealized gains.
When the market finally starts falling, the price hits stop loss and a trader closes the trade in a substantial profit.
The main obstacle with the application of a trailing stop is to keep it at a distance from current price levels that is not too narrow nor too wide.
With a wide stop loss distance, substantial unrealized gains might be washed out with the market reversal.
Imagine you predicted a nice bullish rally on Bitcoin.
The market bounced nicely after you opened a long position.
Trailing stop loss too far from current price levels, all the gains could be easily wiped out.
While with a narrow trailing stop distance, one can be stop hunted before the move in the desired direction continues.
A trader opens a long trade on EURJPY and the price bounces perfectly as predicted.
One immediately trails the stop loss.
However, the distance between current prices was too narrow and the position was closed after a pullback.
And then market went much higher.
In conclusion, I want to note that fixed SL & TP approach is not bad, it is different and for some trading strategies it will be more appropriate. However, because of its limitations, occasionally big moves will be missed.
Try trailing stop by your own, combine it with your strategy and I hope that you will make a lot of money with that!
