18 July 2020
Let’s picture this: you believe you have what it needs to be a trader. As you might have figured out, you need to balance your losses with your profits. You may already know what take profit and stop loss are. You know you can use them to protect yourself. If your analysis was correct, your “take profit” will trigger. If by any chance the analysis did not work, your “stop loss” will get executed. But, what happens if your analysis was right and the market simply took a 180º turn? Your profits might be wiped out. To protect yourself from these situations, trailing stops were designed.
What is a Trailing Stop?
As the name suggests, a trailing stop is a dynamic type of stop. You use a trailing stop to protect potential gains in case the market changes abruptly.
A trailing stop is a type of stop that will move its level if the market is in your favor. That means that if you are on short and the market is falling, the stop will go down too. It is similar if you are longing – if you long and the market is doing well, the stop will rise.
An important thing about trailing stops that you need to know is that you decide the trailing amount. For example, let’s imagine you are longing Bitcoin. Your entry was at $9,150, and you decided to put a trailing stop that starts at $9,000. That means your trailing amount is $150.
If, by any chance, Bitcoin goes up to $9,500, your trailing would be at $9,350. Now, If Bitcoin touches $9,500 and falls, your trailing stop remains at $9,350. That way, you have already locked some of your gains.
Why is a Trailing Stop Important?
As we said earlier, you can use trailing stops to protect your profits. Given this, trailing stops can be a huge part of risk management.
In this sense, a trailing stop is used to apply one of the unwritten laws of trading – To cut the losses quickly and let the gains have as much room as possible.
Yet, trailing stops can be dangerous if misused. For example, a trailing amount too tight might not give enough space in volatile markets. If that is the case, you might end up not only losing the money you traded but also a lose out on a possible winning trade.
How Profit with a Trailing Stop
The first thing you need to know about how to profit from a trailing stop is that you do not set one right away. You analyze the market, and if you decide to open a position, you should do it the traditional way. That means to put a normal stop loss and take profits in place.
If the trade starts going your way, you move your stop loss to entry. That means that no matter what, you will not lose any money. Now, if the trade continues to be favorable, you can change your stop loss for a trailing stop. This way, you know you have locked some profits and give the trade all the necessary space to grow.
How to Set a Trailing Stop
There are several ways to set a trailing stop. Nowadays, almost every trading platform has a trailing stop function. Yet, you can also manually trail your stop loss to a safer place. That way, you can make sure you are locking some profits up.
Now, if you are wondering if there is any way to know how to set a trailing stop, there are two different ways. But, they depend on you. One depends on your technical analysis. If your TA takes into account previous history and support/resistance levels, you already have a clue where to start. The other way is being fully speculative and betting on volatility to do its job. The latter is not recommended, though.
Trailing stops might be one of the best inventions for traders – if you know how to use them in your favor. Our recommendation is to start with a stop loss first. If your first take profit executes, then you can move your stop loss to entry. If you are closer to your second take profit, you can start trailing your stop.
It truly depends on how much faith you have in a trade. If you believe an asset has enormous potential, the best thing to do is to trail.