Trailing Stop
Definition
A dynamic stop-loss order that automatically adjusts upward as a stock's price rises, maintaining a fixed distance (dollar amount or percentage) below the highest price reached.
A trailing stop follows a rising stock price while locking in gains. If you set a 10% trailing stop on a stock at $100, the stop triggers at $90. If the stock rises to $120, the stop automatically moves to $108. If the stock rises to $150 then drops 10%, you sell at $135 — locking in a 35% gain without needing to constantly adjust your stop.
Trailing stops solve the problem of when to sell a winner. Without a systematic approach, investors either sell too early (missing further gains) or hold too long (giving back profits in a reversal). A trailing stop provides a mechanical exit that captures most of a trend while limiting downside.
The key parameter is the trailing distance. Too tight (3-5%) and normal volatility will trigger the stop prematurely, knocking you out of the position before a real reversal. Too wide (20-30%) and you'll give back significant gains before exiting. The optimal distance depends on the stock's typical volatility — more volatile stocks need wider trailing distances.
A common approach uses the Average True Range (ATR) to set trailing distance. If a stock typically moves $3/day and trades at $100, a 2x ATR trailing stop ($6, or 6%) accommodates normal volatility while catching genuine trend reversals.
Trailing stops work well in trending markets but poorly in choppy, range-bound markets where prices oscillate and trigger the stop during normal fluctuations. They're best suited for capturing extended moves in trending positions rather than for every position in a portfolio.
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Frequently Asked Questions
What's a good trailing stop percentage?
It depends on the asset's volatility. For stable large-cap stocks, 7-10% works well. For volatile growth stocks, 15-20% prevents premature exits. For crypto, 20-30% may be appropriate given higher volatility. Base your distance on the asset's typical price swings rather than a fixed percentage.
Does a trailing stop only move up?
Yes — trailing stops only adjust in the favorable direction (up for long positions, down for short positions). They never move backward. Once the stock's highest price sets a new stop level, that level is locked in even if the stock makes a new high and then partially retraces.