What are trailing stop orders?

A trailing stop order is an order type that helps you to maximize and protect gains made on an open position. It's an advanced form of stop order that automatically deploys an order at a predefined point above or below the current price.

Trailing stop orders are beneficial when a trade is going in the trader’s direction but they’re either unable to monitor their position closely or are unsure how far the price will run.

There are two types of trailing stop variance: percentage and constant. You can also set an activation price which will determine when the trailing stop will be in effect to track the market price.

Read on to learn more about what the trailing stop order is and how to apply it effectively in your trading strategy.

TL;DR

• A trailing stop order is an advanced type of stop order that aims to track favorable price movements

• Two types of trailing stop order are available — percentage and constant. With a percentage order, you'd set a trigger point at a certain percentage above or below the market price, depending on the position type (buy or sell). With a constant order, the trigger point is set based on a specific price, such as $30 below market price.

• The trailing stop order is preferred by many traders who lack the time to constantly monitor the markets and manually set stop orders.

• The tool isn't as effective when prices move sideways, or for long-term trading strategies.

Why use the trailing stop order

Trailing stop orders are useful when you want to lock in gains while allowing room for further price growth. As its name suggests, the order type follows the price when a position moves in your favor. By doing so, the sell price of your position rises, increasing your minimum gain should prices then reverse. The trailing stop order can be effective in volatile markets where prices fluctuate unexpectedly. In this situation, you could have the potential to secure higher gains while still protecting your position from a sizable loss.

Busy traders who lack the time to constantly monitor their positions often choose a trailing stop order to maximize the potential from a position they open, because a new stop loss doesn't need to be manually entered.

How to use the trailing stop order

Trailing stop order to sell (percentage) example

Let's say the current price is $100, and you set a trailing stop order to sell your assets at 10% below the market price.

• If the price drops 10% from $100 to $90, your trailing stop order will be triggered and converted into a market order to sell.

• If the price rises to $150 and then the price drops 7% to $140, your trailing stop sell order won’t be triggered. Because the trailing stop order will only be triggered at $135 (10% below the market price).

• If the price rises to $200 and then the price drops 10% to $180, your trailing stop sell order will be triggered and converted into a market order to sell at $180.

Trailing stop order to sell (constant) example

Let's say the current price is $100, and you set a trailing stop order to sell your assets at $30 below the market price.

• If the price drops $30 from your entry point from $100 to $70, your trailing stop order will be triggered and converted into a market order to sell.

• If the price rises to $150 and then the price drops from $20 to $130, your trailing stop sell order won’t be triggered. Because the trailing stop order will only be triggered at $120 ($30 below the market price).

• If the price rises to $200 and then the price drops $30 to $170, your trailing stop sell order will be triggered and converted into a market order to sell.

Trailing stop order advantages and limitations

The trailing stop order is designed to give traders a potential edge in the market. However, it's important to be aware of the tool's tradeoffs. Read on for an overview of its advantages and limitations.

Advantages

• Locks in gains: Possibly the most significant advantage of a trailing stop order is that it can, theoretically, not only lock in gains from a position, but potentially provide higher gains than expected. If you assess the trigger point accurately, you could potentially maximize the gains from a position while also protecting yourself from a price drop.

• Flexible: The trailing stop order aims to work effectively whether prices are rising or falling. Either way, it could help you conduct effective risk management.

• Removes emotion: Given crypto's volatility, it's especially important for you to manage your emotions. The trailing stop order could help in this regard by automating the decision making for you.

• Automates trading actions: Another major benefit of the tool is that it's automated. Once you've done your research and committed to a trade, your exchange's bots can take care of closing the position based on the parameters you set. That's especially helpful in a volatile market when you can't constantly monitor the charts.

• Customizable: You're in control of setting up a trailing stop order, which means you can customize it based on your risk tolerance and wider trading strategy.

Limitations

• Risk of slippage: During volatile periods, you may encounter high slippage as the price of execution differs from the price you expected from your trigger point. For example, when prices crash and there are fewer buy or sell orders to match your trade with.

• Unsuited to long term strategies: Some crypto traders find the trailing stop order limiting when they're looking to open long term positions and are therefore comfortable facing larger prices swings.

• Ineffective in sideways markets: Because the tool relies on prices rising or falling, depending on your position, the trailing stop order isn't so effective when prices are moving sideways. As a result, if you stick to a trailing order in this market, you may miss an opportunity for more rewarding trades.

• Lagging behind the market price: In some situations, your trailing stop order could lag behind the market price, resulting in a late exit and a less favorable price.

• Risk of whipsawing: Whipsawing is another risk of the trailing stop order. This occurs when an asset's prices quickly and unexpectedly move in opposite directions around your trigger point, potentially resulting in multiple losses.

Key considerations when using a trailing stop order

• Your positions and margin won’t be frozen until the trailing stop order is triggered. Please make sure you have enough positions or margin available.

• A trailing stop order might not be triggered successfully because of price restrictions, position restrictions, insufficient margin, being in a non-trading status, and system errors. Once successfully triggered, subsequent market orders might not execute, just like a regular market order. You can find the unfilled market orders under Open Order.

The final word

The trailing stop order is an effective tool for crypto traders to have at their disposal. Like the regular stop-loss order, it's designed to help you minimize losses, but with the added advantage of potentially locking in higher gains, as prices rise and the trigger point follows. Although the tool has its limitations, such as the potential for slippage and its ineffectiveness in sideways markets, it can help you maximize your strategy when the market moves in your favor.

Interested in learning more about crypto trading tools? Read up on stop-loss and take profit, and learn more about crypto order books.