A trailing stop is a modification of a standard stop-loss order that is set at a defined percentage or specific currency amount away from a security’s current market price, automatically adjusting as the price moves in a profitable direction.
Mechanics of trailing stops
A standard stop order remains static at a specific price level. A trailing stop moves with the market price when the market price moves in a favorable direction for the trade. If an investor holds a long position and the asset price rises, the trailing stop price rises by the predefined distance. If the asset price falls, the trailing stop remains unchanged at its highest registered level.
This order type is available across global equity and foreign exchange markets. Traders use the trailing stop to protect capital while allowing a trade to remain open as long as the price continues moving favorably. Once the market price reverses and hits the stationary trailing stop price, the broker triggers the order. Depending on the exact parameters specified by the trader, it then becomes a market order or a limit order.
Elephants utilizing this tool must decide between a percentage distance or a fixed currency amount. A percentage-based stop adjusts dynamically based on proportional price changes, accommodating assets with high daily volatility. A fixed-amount stop maintains a strict numerical distance regardless of the asset’s overall price growth.
Setting the trailing distance requires observation of normal market volatility. If the distance is too tight, standard daily price fluctuations trigger the stop prematurely and close the position. If the distance is too wide, the trader risks losing a large portion of unrealized gains before the order executes.
Example
Suppose an Elephant buys shares in an international agricultural firm at 100 currency units per share. The Elephant places a trailing stop order with a trailing distance of 10 percent. At the time of purchase, the stop price is 90.
Over the next month, the share price rises to 150. As the price increases, the trailing stop continuously recalculates to stay 10 percent below the highest market price. At a market price of 150, the trailing stop is 135.
The market then experiences a downturn, and the share price drops to 140. The trailing stop does not move downward – it remains fixed at 135. The price continues to drop and hits 135. The broker executes the order, selling the shares at the market price and securing the profit for the Elephant.