A trailing stop is a popular forex order strategy that includes shifting a stop loss order closer to the prevailing market once the market has moved in the direction of an established trading position.
Many of the leading foreign exchange firms now allow you to leave trailing stops, and trailing stops can also be done locally in a software manner utilizing some popular forex trading platforms.
Trailing Stop Example
A forex trader might open a long position in EUR/USD with an online forex broker at 1.4500 as an example of how to use a trailing stop. They might then set their stop loss order level at 1.4400 to manage risk in their online trading account, while also placing a take profit order at 1.4700 to achieve their goal.
If they wanted to utilize an automatic trailing stop of 50 pips, they might tell their helpful online forex broker to raise their stop loss level by 50 pips if the market had moved up at least 75 pips from the previous stop level.
This means that if the market trades at 1.4575, their stop loss order will be followed higher to the 1.4450 level automatically. If the market then trades at 1.4650, their stop loss order will be followed up to the trade’s breakeven value of 1.4500. It’s worth noting that using the trailing stop has no effect on the take profit level, and it won’t be lowered if the market moves against you.
Discretionary trailing stops may be preferred by traders who like to judge and watch the market themselves. In this case, implementing such a strategy with an online forex broker would simply include entering a new higher stop loss order, say at 1.4450, then canceling the old lower stop loss order at 1.4400 when the market moved up to 1.4450.
Advantages of Using Trailing Stops
When trading with an online forex broker, using a trailing stop can provide major benefits to trend traders who want to follow a long market trend until it significantly reverses. Traders who employ a trailing stop order approach to protect big profits earned on a position avoid the classic trading trap of allowing a winning position to turn into a loser.
When a trading position becomes significantly profitable, trend traders may choose to apply trailing stops in their online trading account as part of their trade plan. They can then raise their initial stop loss level on the position to the deal’s breakeven point to help avoid losing money on the trade unless the trailing stop slips.
Disadvantages of Using Trailing Stops
Although trailing stops can certainly assist safeguard profits and reduce losses, they can also have significant drawbacks for particular trading strategy types or in certain situations. Swing traders, for example, may find that trailing stops impede their ability to profit from the back-and-forth price action seen in more volatile financial markets.
Unlike a trend trader, who focuses on the current market movement, a swing trader’s main goal is to trade both with and against the trend, as well as any following corrections, in the hopes of earning even more potential profit in their online trading account from the market’s volatility. As a result, utilizing a trailing stop instead of just departing the market when it appears to be ripe for reversal could result in reduced total returns for an active swing trader.
Another disadvantage of using trailing stops is that an online forex broker may take a trend trader out of a position prematurely at the trailed stop level, which has been moved closer to the prevailing market, when the original trade would have been a substantial winner if the stop loss order had been left at its initial level.
