How to Use a Trailing Stop Loss Order

A trailing stop loss order is a dynamic tool for managing investments. It helps protect accumulated gains and limit potential losses. This flexible approach adapts to market movements, allowing investors to participate in upward price movements while safeguarding against significant reversals.

Understanding Trailing Stop Loss Orders

A trailing stop loss order automatically adjusts its trigger price as an investment’s market price moves favorably. Unlike a traditional fixed stop loss, which remains at a set price, a trailing stop loss “trails” the market price by a predetermined percentage or dollar amount. If the investment’s price increases, the trailing stop price moves up with it, maintaining the specified distance. This dynamic adjustment allows investors to let profits run in a trending market, as the protection level continually rises.

Its primary purpose is to lock in profits, allow for further gains, and limit potential losses if the market reverses. It automatically adjusts the exit point, removing the need for constant manual monitoring. This helps reduce emotional decision-making, as the exit strategy is pre-defined. If the investment’s price falls, the trailing stop price remains fixed at its highest adjusted level. If the market price reaches this point, a market order is triggered to sell the position.

Choosing Your Trailing Stop Parameters

Before placing a trailing stop loss order, investors must determine the trailing amount, set as a percentage or a fixed dollar value. This choice influences how much price fluctuation the investment can experience before the order triggers. For instance, a 5% trailing stop on a $100 stock initially places the stop at $95, as would a $5 trailing stop. As the stock price rises, both adjust upward, maintaining their distance from the new high.

The selection of this parameter should consider the asset’s characteristics and the investor’s risk tolerance. Highly volatile investments may require a wider trailing stop (e.g., 10-15% or a larger dollar amount) to avoid premature triggering by normal market fluctuations. Conversely, less volatile assets might allow for a tighter trailing stop (e.g., 5-7% or a smaller dollar amount) to protect gains more closely. Setting a stop too tightly can result in being stopped out by minor pullbacks, while setting it too widely may offer less protection and allow for greater losses. The investment horizon also plays a role, as long-term investors might opt for wider trails.

Steps to Place a Trailing Stop Loss Order

Placing a trailing stop loss order typically involves a series of steps through a brokerage platform. First, navigate to the order entry screen for the specific investment you wish to protect. This screen is usually accessible from your portfolio or the individual security’s quote page. Once there, you will select the order type, choosing “Trailing Stop Loss” from the available options.

Next, you will input the chosen trailing amount, which can be either a percentage or a specific dollar value, depending on your brokerage’s interface and your preference. For example, if you decided on a 7% trailing stop, you would enter “7%” into the designated field. After specifying the trailing amount, confirm all the order details, including the selected asset, the number of shares, and the trailing parameter, before submitting the order for activation.

Monitoring and Modifying Trailing Stop Loss Orders

After placing a trailing stop loss order, it is important to monitor its status and understand how it operates within your investment account. Most brokerage platforms provide a section to view active orders, where you can see if your trailing stop is currently active, triggered, or canceled. This area will also display the current trailing price, which is the actual price point at which the order would execute if the market price falls to that level.

Market conditions or changes in your investment strategy may necessitate adjustments to an existing trailing stop loss order. You can typically modify the trailing amount (percentage or dollar value) or cancel the order entirely through your brokerage platform’s order management interface. If the market price reaches the trailing stop price, the order automatically converts into a market order and is executed at the next available price. This means the sale is initiated immediately, although the exact execution price may vary slightly from the trailing stop price, especially in fast-moving markets.