If you want to make sure you don't hang on to an ailing stock too long, a trailing stop order might be for you. These orders automatically sell a security if it ever falls in value by a certain amount. Unlike a standard stop order, where you set a specific price, a trailing stop order uses an offset amount instead.
As the stock price rises, the trailing stop order follows behind by that offset amount. Once the stock price starts to decline, the trailing stop order freezes. If the price falls to the trailing stop price or below, it triggers a market order to sell.
The result: you capture profits in a rising stock while protecting yourself if it starts to decline.
Placing a trailing stop order
When placing a trailing stop order, you select the amount you want the order to trail the current market price, either as a dollar amount or a percentage. Don't set it too close to the current market price, or it may trigger very quickly.
Like a limit order, you'll also need to select a duration: how long the order should remain active. Here are the most common options:
Day: The order remains active until the market closes. If the stop price isn't reached by end of day, the order is automatically cancelled.
Good 'til cancelled (GTC): The order stays open until it's filled or manually cancelled. Most brokerages automatically cancel GTC orders after 90 days to prevent old orders from being forgotten and unexpectedly executed.
Good 'til date (GTD): You select a specific expiry date. The order is cancelled at the end of that day if it hasn't been filled.
One thing to keep in mind: a stop order isn't placed because you want to sell at that price. It's placed to prevent further losses if the stock keeps falling. With a trai
Trailing stop limit
A trailing stop limit order has two prices to set. The first is the trailing stop price, the offset amount following the market price. Once the market price falls to that offset, it triggers a limit order.
The second is the limit price. Since the stop order trails the current market price, the limit price can't be a fixed number, so you set it as another offset that trails the stop price.
Here's an example. Say an investor wants to sell if a $10 stock ever falls by $2, and once triggered, wants to sell at a limit price no more than $1 below the stop price. If the stock rises to $15 and then starts to decline, the trailing stop price becomes $13 (i.e., $2 below $15). If the price falls to $13, a limit order to sell at $12 or better is sent to the market. As long as the price is declining gradually, the limit order should execute immediately at a price above $12. If the stock gaps down well below $12, the limit order will hold off on selling until the price recovers to $12 or higher.
Using a trailing stop order to buy
You can also use a trailing stop order to buy a security, which is useful if you're waiting for a falling stock to bottom out before purchasing.
When placing a trailing stop order to buy, the offset amount represents how much the security would need to rise before the purchase triggers. Say a stock is falling and an investor wants to wait until it starts recovering. They place a trailing stop order to buy with an offset percentage that follows the stock down. If the stock rises by that offset percentage, the order triggers and a market order is sent to the exchange to buy.
Summary
A trailing stop order is an effective way to exit a position when it turns against you while still capturing some of your gains. Instead of setting a specific price like a standard stop order, you set an offset amount that trails the current market price. As the security rises, the stop order follows. If it ever falls by that offset amount, a market order is sent to sell immediately.
