A trailing stop loss is an order that automatically adjusts upward as a stock price rises, but stays in place if the stock falls. It is a tool for protecting gains without having to constantly monitor your positions.
How It Works
You set a trailing stop at a fixed dollar amount or percentage below the current price. As the stock rises, the stop moves up with it. If the stock falls by the specified amount from its highest point, the order triggers and sells your shares.
Example with a 10% trailing stop:
- You buy at $100. Stop is set at $90 (10% below).
- Stock rises to $120. Stop automatically moves to $108 (10% below $120).
- Stock rises to $150. Stop moves to $135.
- Stock drops from $150 to $135. The stop triggers and sells at approximately $135.
You captured $35 per share in profit (bought at $100, sold at $135) without manually monitoring the position.
Dollar vs Percentage Trailing Stops
Percentage-based: "Sell if the stock drops 10% from its high." More common. Adjusts proportionally as the stock rises.
Dollar-based: "Sell if the stock drops $15 from its high." Fixed dollar amount. Less responsive to percentage changes.
When Trailing Stops Are Useful
- Protecting gains on winners. If a stock has appreciated significantly and you want to lock in profit while giving it room to keep running.
- Vacation mode. When you cannot actively monitor your positions.
- Discipline enforcement. Removes the emotional decision of "should I sell?"
When Trailing Stops Can Hurt
Whipsaw in volatile markets. If a stock drops 10%, triggers your stop, and then immediately recovers, you sold at the bottom. This happens frequently with volatile stocks.
Gap downs. If a stock opens significantly lower than the previous close (due to overnight news), your stop may execute at a much lower price than expected.
Normal volatility. A 10% trailing stop on a stock that regularly swings 8% will get triggered by normal price movement, not a genuine downturn.
How to Set the Right Distance
The trailing stop distance should be wider than the stock's normal volatility:
- If a stock regularly moves 5% in a week, a 5% trailing stop will trigger constantly
- A trailing stop of 15-20% gives more room and is more appropriate for long-term holdings
- Tight stops (5-8%) work better for short-term trades
The Bottom Line
Trailing stops are useful risk management tools, but they are not magic. They work best for protecting large gains on positions you would be willing to sell anyway. They work poorly on volatile stocks or during choppy markets.
The Progressive Trailblazer focuses on helping you understand risk before it materializes. Educational only. Not financial advice.