One important concept that a trader learns in the stock market and in the share market basic course is Trailing stop loss. Trailing stop is also known as stop-loss, do investors take an options strategy. It’s a type of Option trading where investors are given a condition to fix a loss amount or percentage pre-handily. This amount or percentage changes if the market moves in the investor’s favor otherwise, the amount doesn’t change if the market moves against it.
To learn more about trailing loss, this article will give in-depth knowledge of the pros and cons of TRAILING STOP LOSS.
Meaning of Trailing stop loss
Trailing Stop loss is one of the varieties of Option day trading to help to reduce losses. It helps to lock up the profits and safeguard from the loss if things don’t work out according to the plan. Trailing has the potential to capitalize on profits if the market moves in favor. Once it reaches the stop loss, the order gets converted into normal order.
Important: The stop loss target should be above or below the current market price as this option works with current markets.
The stop loss can be set manually by the broker and can be changed when needed or done automatically through the broker or trader’s system.
How does it work?
The order is placed with the preferred stop loss, just like any normal order. Once the market starts fluctuating, the trailing stop loss also keeps on changing its price.
Example: The current market price of a share is Rs 100, and the assumption is that the share will give profits, therefore, profits will come in when entered into a long trade. The stop loss lock-in amount set is Rs 90. If the market price increases from Rs100 to Rs110, the stop loss will change from Rs 90 to Rs 100, increases by more than Rs 10, the trailing stop loss will increase by the same amount. If the market price has come to Rs 120.5, the stop loss remains unchanged i.e Rs 110. And when the price hits Rs 110, the order gets settled, making a profit of Rs 10. This happens when the share price goes up, and if the price goes from Rs 100 to Rs 90, it hits the stop loss, and the order ends there, making a loss of Rs. 10.
LONG TRADE TRAILING STOP LOSS
PRICE
PRICE MOVEMENT
TRAILING STOP LOSS
PROFIT
Rs. 100
Nil
Rs. 90
–
Up
Rs 110
Rs. 100
–
Up
Rs 120
Rs.110
–
Down
Rs 115
Rs. 110
–
Down
Rs 110
Rs 110
–
Rs. 110
Trade Exit
Nil
Rs 10
Now, let’s have a look at the vice-versa scenario. Suppose the chances are that the share price will go down, and entering into short trade is beneficial the current price to enter is Rs100. Here the trailing stop loss set is at Rs. 110. If the price drops to Rs. 90, the trailing stop loss will function similarly, i.e, from Rs.110 to Rs. 100. If the share price goes down by more than Rs 0.5, the trailing stop loss remains unchanged.
SHORT TRADE TRAILING STOP LOSS
PRICE
PRICE MOVEMENT
TRAINLING STOP LOSS
PROFIT
Rs 100
Nil
Rs 110
–
Down
Rs 90
Rs 100
–
Up
Rs 95
Rs 100
–
Down
Rs 80
Rs 90
–
Up
Rs 90
Rs 90
–
Rs 90
Trade Exit
Nil
Rs 10
What to know before entering into the trailing stop loss option?
One major thing that a trader needs to keep in mind before entering into trailing is that it can make you exit the market too soon. For example, when the price pulls itself back, a trader would have left the trade because of a fixed stop loss. To prevent such a situation, try to keep the trailing stop loss at a distance, giving the space for the price to fluctuate.
Another trait is that trailing stop loss doesn’t protect a trader from major fluctuations. For example, suppose the set stop loss is 5% down, and the market dropped to 20%. Before even understanding what has happened, the trade will be left with making a 5% loss.
Therefore, the trick is that every trader should follow is that he should always keep enough room for the option trade to fluctuate but only till the trader can handle like 15% or 20%.
To Conclude
Trailing stop loss is beneficial for all traders as it can help reduce loss, but you can always look for the other alternative like trailing stop loss limit order, where you have an option of setting up a better price compared to the market price.
And most importantly, before just starting to trade, do have complete knowledge of option trading in the stock market. Or one should join a share market basic course that gives an in-depth and practical knowledge on TRAILING STOP LOSS.