From Points to Pips- The Pros and Cons of Using a Trailing Stop
In the community, I have been getting a lot of questions as to exactly what a trailing stop is and how to use it in certain trades. In this article, I'm going to go over the simple definition of a trailing stop as well as when it can be used to help improve traders' profits.
What is a Trailing Stop?
A trailing stop, or TS, defined by Investopedia is "a modification of a typical stop order that can be set at a defined percentage or dollar amount away from a security's current market price. " In other words, a TS is something you can set on MetaTrader that will lock in profits if your trade goes in the direction you want. The user can activate a trailing stop and set it to however many points away from the price they want. I don't know exactly why MetaTrader does it this way, but you have to set your Trailing Stop through units of points. For every 10 points your trade moves, that's 1 pip. So a 100 point move would be 10 pips. For example, if you're long on any pair and you set a 100 point TS, your TS will activate after the price moves up 10 pips, moving your stop order to break even. However, if prices continues up another 10 pips, you are at 20 pips in profit, and now your TS lags 10 pips behind, locking 10 pips in overall profit.
Here is an example trade on GBP/USD. The blue line represents what my TS would have been for this trade. If my sell limit got filled and prices made a 100 pip move, which this is, a 100 point trailing stop would lag 10 pips behind profit, locking in 90 pips profit if prices don't continue further down. I didn't draw the TS exactly 100 points behind the price, but hopefully this gives you an idea of what a TS is and how it operates.
The best part about this feature is that you can guarantee yourself profits at any point in the trade when it moves in your favor. Another cool thing is that you can choose however many pips you want to risk. Once the trade moves in the direction you chose, it can eliminate the risk:reward and establish a reward:greater reward ratio. In a good trade with a TS, you're no longer risking losses, rather you're risking how much profit you want. On that fake GU trade, you could have decided to lock 50 pips (500 points) in profit, giving the trade more room to move. Or, you could be ready to close the trade, but don't want to miss out on an opportunity to see GU slide further down. So you set a more aggressive TS of 100 points (90 pips in profit).
The problem that you can run into when trading with a TS is that it will limit price action. So, if prices moved just like that GU trade, my TS would've been hit much earlier as prices came up for a retest before continuing downward. The key to trading with trailing stops is to pick a direction on your trades. You don't have to set TS before you make the trade; it can be done at any point during the trade. Maybe you want to lock 20 pips profit but do not set a TS until the price has moved 40 pips. Then you could set a 200 point TS that will lock 20 out of the 40 pips to guarantee profit. I know your possibly cutting your profit by half, but you can never go broke from taking a profit. And if you realize that you are happy with a 40 pip move, you can always just close the trade for full profit.
Trailing Stops are very helpful in my opinion, and I like to use them when pairs can't pick a direction for the short term. I especially like TS when I trade indices like the US30 because it's so heavily leveraged. Traders might think that TS is an offensive way to trade for those who are ready to take profit, but really it's a defensive scheme and a very helpful tool in risk management. Sure, you can limit profits, but there is nothing wrong with protecting your money.
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Please note that this email is my personal opinion only. I am not a licensed financial advisor, and any information shared or discussed is not to be construed as investment advice. Trading and investing involves a degree of risk, and is not suitable to all investors. Please consult with your financial advisor before making any sort of investment decisions.
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