What is a Forex trailing stop?
Smart traders know the importance of using a stop loss order, but is a trailing stop better?
usual, we must start by explaining what a trailing stop is:
A Forex trailing stop (or just a trailing stop used in currency markets) is a stop loss order which adjusts dynamically as price moves.
Time for examples:
If you set a trailing stop at 20% of price, then if price moves down 20% you will be stopped out.
But if price moves up, the stop doesn’t just stay static as before…
No, the stop will consider the new, higher price before counting %s down for closing the position.
So, if you invest $100, the initial stop will be at $80, but if price moves to $120, then your stop will also move “up”.
In this case, to be stopped out, you will have to reach $100.
Had price moved up more, or had you had a tighter stop (say 10-15%), it’s possible you could have locked in some of that profit.
In the same case, using a trailing stop of 10%, price would have had to fall from $120 to $110 to be stopped out (at a profit).
Isn’t it great?
You don’t have to adjust your stop loss so often, or pay so much attention to it since you will always lock-in profits or reduce your risk!
Using a trailing stop can be useful, however, there are a few limitations.
One of these limitations, and in my opinion the least worrisome one, is that some trading platforms require you to have the platform open and on for the trailing stop to trail.
So if you close the application, or turn off the power of your computer, the stop will not continue to adjust.
While I don’t have in-depth knowledge on which platforms have this issue, it is worth nothing. You should make certain of this feature before confidently letting a trade on its own.
Secondly, and perhaps more importantly, a Forex trailing stop adjusts too quickly for most professional traders’ taste.
What do I mean?
As you’ve heard at forexeconomist.com before, you should manually adjust your stop loss orders and place them near strong resistance or support zones.
This is because price may swing either way, but such zones will serve as safeguards or “shields” to your position.
Say USD/CAD has a strong resistance zone at 1.2600. You shorted it at 1.2570 and placed your stop at 1.2620.
Hence, you’re using the 1.2600 zone as a shield for your position. If price goes back up, it will likely get shorted as it approaches the 1.2600 resistance zone.
In most cases, this resistance will hold unless a strong fundamental reason (shift in sentiment) against your trade occurs.
But if you have a trailing stop, your stop loss might get past the 1.2600 resistance zone.
If does so, in many, many cases, price will swing back to check the zone, and you will be on the wrong side of the fence…
Hence, you will be stopped out before you should have.
means, you either lost some pips unnecessarily, or you didn’t make as many as
you could’ve since you were stopped out before price resumed a bearish trend.
What would be a better way of adjusting the stop?
Say price moves in your favor significantly, and is now around 1.2437
You notice there was another resistance zone around 1.2500. So you manually adjust your stop loss order to 1.2530, thus locking some good profits, but also staying protected by another zone, in case price backs up.
And that’s a simple example of how you should use a stop loss with technical levels in order to give profits room to grow, while keeping risk in check.
don’t need a Forex trailing stop to do this, and as I just explained, it can be
(and usually is) counterproductive when it comes to letting profits run.
That’s my take on Forex trailing stops, hope you found it useful.
See you soon,
The Forex Economist
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