Trading order types serve the purpose of instructing the stockbroker on when to enter or exit the trade on behalf of the trader. The order type chosen has a significant impact on the outcome of the trade. Of the many trading order types, a crucial one is the Trailing Stop Loss Order.
A trade may be going against the expectations of the trader, but the order type placed is appropriate, the trader may be able to save himself from heavy losses, along with being able to reserve his profits.
What is Trailing Stop Loss?
Trailing Stop Loss order is similar to a stop-loss order, except being dynamic. Instead of placing a stop price, a stop parameter is placed, which is usually a percentage, that creates a moving or trailing stop price.
The stop price keeps on changing in the trailing stop loss, according to the performance of the security in the market.
It combines the characteristics of both risk management and trade management. The purpose is the same as to protect and maximise the profits when the stock price increases and limit loss when the stock price falls.
They are also called profit protecting stops as they lock in the profit already made and cap the amount that can be lost if the trade does not work out in the favour of the trader.
In most cases, the best design is to use trailing stop loss along with stop loss.
For instance, a sell trailing stop loss orderplaces the stop price below the market price at a fixed point, along with a trailing amount.
If the market price of the security rises, the stop-loss price also rises with the trailing amount, but if the market price falls, the stop-loss price does not change and the trade gets executed as soon as the stop price is reached.
This widely used mechanism helps to limit the losses by putting a lower limit but does not put a limit on the maximum possible profits. Similarly, buy trailing stop loss orders can be used in combination with stop-loss orders in falling markets.
Trailing Stop Loss Example
For example, a trader buys the shares of UPL at ₹720 and places a trailing sell stop order of ₹72 which is 10% of the current price. So, the sale will be triggered as soon as the price reaches ₹648.
However, if that low is not reached, the sale will not happen. The price of UPL shares then reaches a high of ₹750 instead of going down, so in this case, the stop price will automatically change to ₹675, which is 10% trailing stop loss of the high.
Thus, the stop-loss price keeps on changing as the price of security changes.
In a long trade, the trailing stop loss price goes incrementally higher following the price as it goes higher, and in a short trade, the trailing stop loss price falls as it follows the price falling.
Trailing stop orders can also be converted to limit orders if the limit price is mentioned. Like all limit orders, they may or may not get filled and may get partially or completely filled. They do not guarantee execution.
Trailing stop loss and limit orders are both available on all listed securities and the trigger is taken from the last trade and can be entered as day orders or good till cancelled orders.
Therefore, in order to make the best out of a trade, the traders are advised to use specific order types.
In volatile markets, like intraday trading, it is suggested to use trailing stop loss along with the stop-loss orders, to make sure that the capital remains conserved and does not go away in huge losses.
Advantages of Trailing Stop Loss
There are some benefits of using a trailing stop loss in your trades, as mentioned below:
In case your analysis is incorrect, then you automatically exit from your trade with a pre-decided monetary loss.
However, if your analysis is correct, then there is no limit to the potential profit you can churn out of the trade. The best part is that your stop loss moves along with the market movement of the stock.
There are no separate charges of using a trailing stop loss in your trades.
Meaningful investment with much-limited losses.
Disadvantages of Trailing Stop Loss
At the same time, you might face a few concerns while using it. Here are discuss:
Whether we talk about stop loss or trailing stop loss, there is no 100% guarantee that the price you have set is going to get hit exactly as is. There are chances of a sudden price drop and your exit may be at a price much lower than the stop loss you had set.
This concept requires you to be disciplined in your trades, setting up the target price you are looking to exit off. If there is no clarity there, the trader won’t ever know the “right” time to leave the stock and book the profit.
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