How to Lock in Profits with Trailing Stops

Posted on by The INO.com Team

Today I'd like everyone to welcome David Waring from InformedTrades.com to come and teach us a bit about the all important trailing stop loss method! It's always a top question among members and David makes it clear the best methods to use. Enjoy and feel free to comment!

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In all my years one of the most frequent topic I discuss is the psychological difficulties people have with letting their profits run, and how the concept of the trailing stop is one way traders can overcome these difficulties that are the downfall of so many traders.

Once a position has begun to move in a traders favor many successful trader’s will manage that position through the use of what is known as a trailing stop. The simplest type of trailing stop is what is known as a fixed trailing stop which simply moves along behind a position as that position begins to move in the traders favor. The beauty of the fixed trailing stop, is that while it will move up behind a long position or down behind a short position as the position moves in the traders favor, if at any time the position begins to move against the trader, the stop does not move, essentially locking in a large portion of the gains the trader has made up to that point.

Let’s say for example that you had been following the trend in the EUR/USD chart below which started back in August and were looking for an opportunity to get into a trade. Based on your analysis you decided that if the market broke out above the little resistance point that I have highlighted on the chart below and the Average Directional Index (ADX) was in a good position that you were going to enter long at 1.4360 to try and ride the trend. To manage the trade if it moved in your favor you placed a 100 Point trailing stop on the position at 1.4260. Now in this example if the market moved against you from the start 100 points your stop at 1.4260 would not have moved and you would have been executed on that order when the market touched 1.4260. As you can see from the chart below however, in this example the market did not pull back but went higher. As our stop is a 100 point trailing stop once the market moved up from 1.4360 the stop is going to continue to move up remaining 100 points behind the current price. If the market moves down however the stop does not move. So in this example once the market stoped moving higher at 1.4752 so did our stop and since the market pulled back 100 points from that level we were stopped out in this example at 1.4652.

Most trading platforms will allow you to set a fixed trailing stop on the platform so you do not have to manually manage the order.

As we have touched on briefly in previous lessons, indicators can also be used as trailing stops. One of the more popular indicators which was designed specifically for this purpose is the Parabolic SAR which we covered several lessons ago and you should review if you have not done so already.

As we discussed in our lesson on the Average True Range (ATR), this and other methods for measuring volatility in the market are often used to set hard stops by traders when entering the market so they do not get stopped out by market noise. In addition to using the ATR as a hard stop, this and other volatility based indicators can also be used as a trailing stop, moving your hard stop along behind the position a set number of ATR’s for instance as it moves in your favor. As with a hard stop this protects your position from market noise, while allowing you to look in profits should the market begin to move against you.

Many if not all of the other indicators could also be used as trailing stops with the Moving Average probably one of the more popular here as well.

Aside from fixed and indicator based trailing stops another strategy that many traders implement is a fixed percentage of profits trailing stop. Using this method a trader will set his hard stop his profit target, and then once the market hits his profit target will then begin trailing a stop which could be any combination of the methods above. This method gives the trader a greater chance that the trade will hit his profit target but provides less protection should the market reverse and begin to move against him.

David Waring
InformedTrades.com

23 thoughts on “How to Lock in Profits with Trailing Stops”

  2. Does anyone know where I may find other coverage of this subject? I've been looking but have not seen an archive with the other articles on this.

    Brad mentioned 'previous lessons' and I would very much like to follow up if anyone knows where I may find them.

    Thanks.

  3. Hi aldo Hi mirko,
    I totaly agree with you mirko about alerts in forex, not only agree but I have already asked Adam in two different occasions(dont remember when) about the 4 hourly triangle, when he will add it to the chart softwear .
    because I am swing tader ,but even so, daily and weekly signal does not fit( i dont mean it will not work, it will work of course but over relatively very long period if we are talking about forex)
    one more thing, whatever been said and will be said , I DONT BELIEVE IN DAY TRADING , thats the game of neobies.
    I hope Adam will answer my question( and please dont jump again in Neoziland or any place else, because we were all worried about you).
    yosry

  4. Hello
    I wander what is alert...When I had subscription that alert was useless.Why? because When I am loged in alert doesnt pop up on the screen in real time...it was sent by e-mail...Also those triangles should appear on lower time frames not only for Day or week or month...Simple for intraday trading...I trade forex which is 24 hours open...I have no need to wait days and months for triangle to show up...

    Let me know when you meet my requirements...

    Regards

  5. Hi Yosry
    No, it is specifically for stocks, which I find works very well for me.
    It could be adapted for the forex market,I think you can 'drill down' to the next lower time frame (ie 4hr/2hr chart) you just need to know (like you stated) tha atr . The forex market is highly volatile, as you know, so you have to be careful about putting in too tight a stop. I personally don't like to trade intraday because of this. I think daily/weekly charts are less stresful and you can take your time in assessing your positions (ie; once a day/week)and allow your trades to 'breathe'. Intraday trading,I find, is too precarious, and Iv'e had my fair share of losing trades, and feel that a more calm, timely approach leads to better calls.Remember, the only people that end up making money on 'intraday mania' are the brokeage firms, who couldn't care less if you win or lose, they get paid on every trade you take, and know that in the end, the average trader gets too carried away in the excitement of 'trading'. There is a growing industry built on 'suckering' people to buy 'robots', systems etc. As you know 90% of traders LOSE money, the next 5% break even! Trading should be 'boring' and executed in a calm, non-excited way. That's way Adam Hewison's Trade Triangle technology is made specifically for the Swing Trader, and is great for executing trades, giving specific signals on a daily to weekly basis. Remember, it's not the quantity of trades, but the QUALITY that's the most important thing. Again, not LOSING money, and letting the profits 'run'.

    I hope this helps Yosry

    All the very best

    Aldo

  6. thanks bobby,
    but i was more specific . i was not talking about stocks od future. i was talking specificaly about forex, and more specificaly about EUR, minding that daily ATR (average true range)of EUR fluctuates between 150-200 pips
    yosry

  7. Hi aldo,
    did you trade forex using the same tactics? because 0.5% is slightly large in forex i think.
    yosry

  8. Hi there everyone
    Here in the uk we do what is termed as 'Spreadbetting' which involves highly leveraged stocks, rather like FOREX.
    I find that once I've entered a trade,I enter my stop below the lowest significant bar if going long (vice versa if short)and trail my stop on the next closed candlestick, minus spread, minus 0.5%, and do that deliberately on every closing bar, until I get 'stopped out'. I know this is an aggressive strategy, but PRESERVING capital is THE most important thing in my books, out of any trading position, and I find that although you trade more often, you are following a profit orienteered system (hopefully larger win, smaller loss) and don't have to worry about exiting, as your 'stop' will do it for you.Plus you want to get to 'breakeven' as quickly as possible, so you can have a 'free trade', and not worry about the possiblity of reversals and LARGE losses!
    I hope this helps anybody out there, and value any 'feedback' from my fellow traders

    All the best

    Aldo

  9. Hi David,
    just to carify;
    if i am using fixed trailing stop as in ur example above, so lets say if i went long at 1.4360, so when should i move my trailing stop to 1.4460 ? is it when the price hit 1.4560?
    thanks

    1. I think it depends on the type of trade, ( futures, stocks currencies etc) and the volatility of the trade. If, for example, a 100 point gain represent a really nice profit, you would do well to bring in a trailing stop to at least your opening entry and probably closer..You do not want to take a chance on being taken out by freakish market action resulting in a reversal and having to pay for it too!!l.. I am always looking for an opportunity to get into "no risk" situations by moving my stops into areas I think I will be safe and allow the profit to run...Rule of the thumb I think is to always lock into some profit once the trade is in your favor..That is exactly what a trailing stop would for you..From watching your charts and assuming no freaky stuff occurs, you can judge when the trade is beginning to fade on you and then move your stops to take advantage....

      Some platforms allow a "trigger" point before the trailer is set in motion. One very conservative play I like to use is a one conceals the other type of trade... This allows you to place an entry order, exit order and stop loss all at the same time..conservative in that you are limiting the max profit run but nice to know when you are going in, what your risks are and your potential profit..Once one side of the trade is triggered, the other side is cancealed.

      Bobby

  10. I agree with Bobby too. I swing and day trade (more the former) and use trailing stops a lot. What I do (when I'm being disicplined, that is) is start with an 8% stop ala Bill O'Neil of IBD, or stay glued to the screen and do that manually. As the position rises to say 7-8% gain (remember this is swing trading, not investing where you'd be looking for a larger number) I will move the stop percentage up closer, perhaps even into the region where market noise might trigger it, and breath a sigh of relief, knowing that I have absolutely locked in some of the possible profits on this trade.

    Indeed, if I set them too close at that point, I can almost count on one triggering the same day, but sometimes you get lucky and get a nice long run even with a pretty tight (2-3%) stop. Yes, there are times noise trips you out, then the issue keeps gaining thereafter. A bummer, but no one ever got broke taking profits and risk off the table either. You can usually identify the next dip and get back in for the continuing ride in that case, as well.

    This doesn't work as well as a perfect emotionless human trader might do, but I don't know any of those, and it sure reduces my stress levels in these wild swinging markets, allowing me tp play very risky things I wouldn't otherwise.

    Now, don't we all wish for a noise filter on those stops -- something like "don't trip until at least 3 trades"? I know I do -- the noise that trips a tight stop is often just one oddball trade, whereupon the stock continues to rise.

    I haven't found a platform that allows this yet, but am writing some software of my own to use my broker's web API to do just that. Seems like it would be a large advantage in a lot of cases. Obviously, the simple software strategy I mention above would allow some losses below the stop price, but I'd bet that in the long run, and even most short runs, you'd capture more profit per trade.

  11. I would suspect that trailing stops are good for long term trades in which the profit target is expected to over exceed the range of the stop enough to maintain a good return..(swing or position trading) would be a good example..If the ATR indicator as mentioned in the article is used for example indicates a range of say 25 points for argument sake. that means the a position may range 25 points/bar..Up or down.. A trade may go to 24 and reverse 26 and cause a stop put. The trader just lost a 24 point profit.and suffered a loss...
    A compromise would be to set a "wide stop" to gain entry, as the trade approached the desired profit exit, narrow the stop considerable in order to gain as much of the profit as possible.. Set trailing stop and forget approach is not a good idea......

    Point is, trailing stops should be carefully used in trading both in setting the range and managing them as the trade progress..

    my 2 cents

    Bobby Cook

    1. Hey Bobby,

      Thanks for your insight here I think you make a good point.

      For me personally and from my experience watching thousands of traders trade, trailing stops are generally problematic for daytraders and work better in a swing or position trading type strategy (Although I am sure there are exceptions).

      Where a daytrader can use the information I have outlined above I think however is simply to get an idea (using the ATR) of where they can think about their non trailing stop, to get it in an area where they are outside of the "market noise" on the timeframe that they are trading.

      One of the things I love about the internet, is that it gives me the ability to get feedback like this on my ideas, and give my feedback on others in a way where there is no limit to the amount of people who can benifit from the discussion.

      With this in mind if you or anyone else has thoughts to share on this please post them as I would love to continue the discussion here. Also don't worry about offending me if someone doesn't agree with something that I have said or am saying, as I am here to learn to so I try to keep my mind as open as possible to exploring existing and new ideas.

      Happy Trading!

      Dave

  12. Hi there,
    Actually I did not understand exactly what you mean. Must be clearer.

    1. Hi Erdal,

      Sorry about that if you have specific questions on an area that I can address for you that you do not understand I will be happy to do my best to clarify. I view my job as to learn with and help other traders learn trading so obviously if I am not explaining something well I want to improve on that.

      Best Regards,
      Dave

    1. Yes I look at options as a volatility guage but have not gotten into them for risk management or straight market plays yet. Something I am interested in learning more about though with the community.

      Best Regards,
      Dave

  15. Hopefully I don't have you mixed up with someone else....but I seem to recall that you were paper-trading the marketclub triangles for forex?

    If so, how is that coming along?
    bmcgee

    1. Hi Barry,

      Thanks for the comment. Yes that is me but I was paper trading them not just for forex but on all the instruments that I trade. I got off to a bit of a rough start as I was using my own stops instead of following Marketclubs so I took a few big hits right in the beginning but once I fixed that the triangles performed very nicely for me. You can see all the trades that I did with them on "David's Marketclub Trading Diary" in the trading journal section of the InformedTrades Discussion forums (link in the top navigation).

      I have now finished the first stage of my review which was papertrading, and am preparing to go live, and will be posting my results there as well.

      Thanks again for the comment, and let me know if there are any other questions.

      Best Regards,
      Dave

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