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Trailing Stops for Beginners
By Kim R. Gibas, Senior Branch Manager, Delafield, Wis.
Trailing stop orders can be a very useful type of order, but they're commonly misunderstood. So, this is a follow-up article to Stop & Stop Limit Orders for Beginners that was published in the July issue of KnowHow News, and my goal is to demystify trailing stops for beginning investors.
Understanding Trailing Stop Orders
Trailing stop orders, like stop and stop limit orders, can help limit a loss or protect a gain. The key difference is that your order will move with the market and you will set a percentage or point trigger versus a set price per share. The trail will follow the stock as long as the stock continues to move in a direction that is favorable to you: up for a sell order and down for a buy order. Once the stock changes direction, the trail stays at its last price, and when the stock hits or passes that trail price, the order is triggered.
Your trail is updated based on the price of trades executed at or within the National Best Bid/Offer (NBBO), and the order also triggers off the NBBO (the bid price for sell orders and the ask price for buy orders).
Let's look at how this works with a few examples.
Sell Trailing Stop Orders
Here is an example of a trailing
sell stop using a
percentage:
Stock price is $38.00 and trail percentage is 10%. In this example, you will see how the trailing stop price moves upward along with the stock price until the stock changes direction:
As you can see, the trail is always 10% lower than the price of the stock. At $38.00 per share, the trailing stop was $34.20 ($38.00 x 10% = $3.80; $38.00 - $3.80 = $34.20). Then, when the stock took a downward turn, the trail leveled off at $46.80. When the stock price dropped past the trail amount, the order was triggered and was entered as a market order. This means it was placed at the next available price, which was $46.00 in this case.
When using a percentage, be careful to set it at a level that will pick up a true price drop as opposed to normal daily price fluctuations.
Here is an example of a trailing
sell stop using
points:
Stock price is $38.00 and points are $3.00. In this example, you will see how the trailing stop price moves upward along with the stock price until the stock changes direction:
Once again, the trail is below the stock price by the selected amount, $3.00. At $38.00 per share, the trailing stop was $35.00 ($38.00 - $3.00 = $35.00). Then, when the stock took a downward turn, the trail leveled off at $49.00. When the stock price dropped past the trail amount, the order was triggered and was entered as a market order. This means it was placed at the next available price, or $46.00.
When using points, be careful to set it at a level that will pick up a true price drop as opposed to normal daily price fluctuations.
In both examples, it is important to note, the trailing
sell stop only goes up; it never goes down with the market price. So, as long as the stock keeps rising or holds relatively steady, the order does not execute. However, if the market price turns downward and hits or passes your trailing stop, your order will be triggered.
Buy Trailing Stop Orders
Here is an example of a trailing
buy stop order using a
percentage:
Stock price is $50.00 and trail percentage is 10%. In this example, you will see how the trailing stop price moves downward along with the stock price until the stock changes direction:
With buy orders, the trail stays above the stock price by your designated percentage until the stock price moves upward. At $45.00 per share, the trailing stop is $49.50 ($45.00 x 10% = $4.50, $45.00 + $4.50 = $49.50). Then, when the stock took an upward turn, the trail leveled off at $31.90. When the stock price rose past the trail amount, the order was triggered and was entered as a market order. This means it was placed at the next available price, which was $35.00.
When using a percentage, be careful to set it at a level that will pick up a true price drop as opposed to normal daily price fluctuations.
Here is an example of a trailing
buy stop order using
points:
Stock price is $45.00 and points are $3.00. In this example, you will see how the trailing stop price moves downward along with the stock price until the stock changes direction:
Notice the trail stays above the stock price by your designated percentage until the stock price moves upward. At $45.00 per share, the trailing stop is $48.00 ($45.00 + $3.00 = $48.00). When the stock took an upward turn, the trail leveled off at $32.00. When the stock price rose past the trail amount, the order was triggered and was entered as a market order. This means it was placed at the next available price, which was $35.00.
When using points, be careful to set it at a level that will pick up a true price drop as opposed to normal daily price fluctuations.
In both examples it is important to note, the trailing
buy stop only goes down, it never goes up with the market price. So, as long as the stock keeps rising or holds relatively steady, the order does not execute. However, if the market price turns upward and hits or passes your trailing stop, your order will be triggered.
The material provided in this article is for informational purposes only and its use does not guarantee a profit.