By Warren Seah – Let’s start off with an introduction of what stop loss is which is an order placed with a broker to sell a security when it reaches a certain price. It is designed to limit the loss of a security position of an investor and often termed as stop order or stop market order.
In the case of trailing stop loss, it is just a set of more complex rule for stop loss to automatically shift accordingly to market conditions whereby the trailing stop loss behaviour is predetermined by the trader. More often than not the employment of trailing stop loss is overlooked with preference on the focus of entry strategies by many traders.
If you have experienced trading before and you tried to outsmart the market without a stop loss, how many points do you allow the market to move against you? 100points, 200points or 1000points? If it happens, how do you handle such a situation or did you just lay battered and bruise over the huge losses you have incurred because of your stubbornness?
I have been through such situations before and it was a torture until I have learnt my lesson on placing stop loss. Upon further experimentation with stop losses, I have come across something even more powerful which is the trailing stop loss.
The trailing stop loss order is beneficial in that it will follow the movement of the market when the order starts to profit. When you profit, the stop loss you set will move up a certain number of pips set by your own trailing stop rules as the market moves in favour of your trade position. Otherwise should the market go against your position, the stop loss will stay where it last trailed and will exit the trade should the market price hits your stop loss.
For example, if I am trading currency and I bought EUR/USD at 1.3000 with a stop loss of 1.2800. the market price rose up by a 100 points, at this point if I were to shift my stop loss to break-even point, I will just be trading on the risk of my profits and any other further movements upwards allows me to ride on the profits.
In short, if the market continues to move in your favour, trailing stop loss will rise along with it, locking in your profits whenever the market price reaches a certain level. If the market goes against you, the trailed stop loss is there to limit the damage on your profits or in the worse case even it does not trail, you do have your fundamental stop loss level in place.
As you progress further in your trade, never forget the number one rule which is to protect yourself in the market at all times. Only by having protective stop or in a more advanced case which is the trailing stop loss that you can prosper in the markets or survive another day even after a bad fall.
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Warren Seah
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