Can someone explain a trailing stop?

Question

I've read the Investopedia entry on a trailing-stop, but what I don't understand is this: If "the price of the stop-loss adjusts as the stock price fluctuates," then when the price goes down, the stop-loss point goes down too, and it would never be executed.

Answer 1

Quick answer:

When you set a trailing stop, it serves to protect profits. The trailing loss only adjusts up, but not down.

That's also a good rule of investing. You want to use trailing stops to lock in profits, and not give them back by adjusting them just because a stock pulls back.


Further fodder:

Be careful though, some brokerages handle trailing stops better than others. Some only let you trigger a trailing stop based on your stock price, some allow it to trigger off of anything! Some allow you to set it based on the bid price, the last traded, or the ask price. This is very important if your stock is not very liquid.

Typically, if you have a trailing stop on stock, you'll do it based on the LAST price. But if you set a trailing stop on an option, you'll set it on the BID price.


Even more fodder:


Some brokerages allow conditional orders! These orders are held IN HOUSE (not visible to the market maker on the floor), and only get submitted once your condition is met. This type of order (and flexibility that it provides) is not available from all brokerages. And some which do offer it (like Fidelity) totally suck at it. So be careful. Firms like optionsxpress are good at it. And what it allows, is for you to set your framework for your trade.

Sell here if profits get to this point. Sell here if the market pulls back to here. That sort of thing. :-)

Hope that helps!

Answer 2

As an example, consider a trailing sell stop placed on a Microsoft that is currently trading at $20. Assume that you enter a trailing stop to sell the option at the market if the price declines $1. This order provides downside protection at the current moment and for the current price. Suppose, however, that the call rises quickly to $30. . Not to worry! The trailing stop order automatically sets the trigger price to $30 minus $1, or $29. New trigger points are updated without any effort by the trader.

Answer 3

Yada explained it very well, that a trailing stop it to protect profits. And the example by the poster of Microsoft shooting up to $30 with the trailing stop adjusting appropriately is also a very good explanation.

But, what most of the posters failed to tell you is that a trailing stop will only adjust up, not down on a LONG position. In a SHORT position, the trailing stop will only adjust down, not up.

In other words, the trailing stop adjusts in the direction of the given trade - up in long (expecting market to rise) or down in short (expecting market to fall) trades.

Hopes this adds a little to the above explanations.

Answer 4

You almost have it. The trailing stop follows the price *up* only. As the price rises, so does the stop. If the price falls, the stop is triggered.

Answer 5

Driftwood has it right. The trailing stop is to protect you if the stock falls to protect your profit. You don't move it down if the stock goes down.

Answer 6

The trailing stop will triger when your condition met. It will execute when the price fall at the triger or below the triger point

Answer 7

the trailing loss adjusts up, but not down.

http://www.investorwords.com/5044/trailing_stop_loss.html