Trailing Stop
Definition
A Trailing Stop is a flexible stop-loss strategy that differs from a fixed stop-loss by automatically adjusting the stop-loss position based on the asset's price fluctuations.
Its purpose is to lock in profits when the market trend is favorable while limiting losses if the trend reverses. A trailing stop sets the stop-loss position by tracking the maximum favorable price movement, ensuring that the stop-loss position adjusts accordingly as the price reaches new highs or lows.
Components and Calculation Steps
Maximum Favorable Excursion (MFE): The highest profit point reached after opening a position.
Trailing Stop: Also known as the retracement percentage, it is set based on the maximum profit point. When the price retraces to this percentage from the maximum profit point, the position is closed.
For long positions, the trailing stop moves up with the price but remains unchanged during price retracement. When the price retraces to the set retracement percentage, the stop-loss is triggered. Calculation method:
Trailing Stop = Highest Point × (1 − Retracement Percentage)
For short positions, the trailing stop moves down with the price but remains unchanged during price rebounds. When the price rebounds to the set retracement percentage, the stop-loss is triggered. Calculation method:
Trailing Stop = Lowest Point × (1 + Retracement Percentage)
How to Use a Trailing Stop
Set the Trailing Stop: Choose an appropriate retracement percentage based on your trading strategy and the asset's volatility to balance the frequency of stop-losses and the potential for profits.
Advantages and Disadvantages of Trailing Stop
Advantages:
Locks in Profits: In favorable market movements, it locks in partial or full profits, ensuring that gains are not erased by a market reversal.
Limits Losses: In unfavorable market movements, it promptly triggers the stop-loss to limit further losses.
High Flexibility: Automatically adjusts the stop-loss position based on market fluctuations, adapting to different market environments.
Disadvantages:
Potential Early Stop: In highly volatile markets, it may trigger the stop-loss too early, causing traders to miss subsequent profit opportunities.
Complex Setup: Requires reasonable setting of the trailing amplitude and retracement percentage based on market conditions, and improper settings may affect trading outcomes.
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