A trailing stop-loss is a dynamic risk management tool used by traders to protect profits while allowing for potential upside in a position. Unlike a fixed stop-loss order, which remains at a set price level, a trailing stop-loss automatically adjusts as the market price moves in a favorable direction. This feature makes it particularly useful for capturing gains in trending markets without prematurely exiting a position.

How a Trailing Stop-Loss Works
When you enter a trade, you can set a trailing stop-loss at a certain distance from the current price, expressed either in points, pips, or as a percentage. As the price rises, the trailing stop moves upward with it, maintaining the defined gap. If the price reverses and moves down by that distance, the stop-loss triggers and closes the position, locking in profits or limiting losses.

Formula:
Trailing Stop Price = Highest Price Achieved – Trailing Amount

For example, if you buy a stock at $100 and set a trailing stop-loss of $5, initially, your stop-loss is at $95. If the stock rises to $110, the trailing stop adjusts to $105 (110 – 5). Should the price then fall back to $105, the stop-loss order executes, helping you secure a $5 profit instead of allowing the price to drop back to your initial entry point.

Real-Life Example
Consider a trader dealing in forex, buying EUR/USD at 1.1200 with a trailing stop set at 50 pips. The price moves up to 1.1300, so the trailing stop moves up to 1.1250 (1.1300 – 0.0050). If the pair then dips to 1.1250, the position is closed automatically, ensuring the trader has locked in a 50-pip gain rather than risking the trade reversing all the way back to the entry price.

Common Mistakes and Misconceptions
One common misconception is that trailing stop-loss orders guarantee profits. While they help protect gains, trailing stops do not eliminate risk entirely—especially in highly volatile markets where price gaps or slippage may cause the order to fill at a less favorable price than expected. Traders should also avoid setting the trailing stop too tight, which can cause premature exits during normal market fluctuations, or too wide, which might expose them to larger losses.

Another mistake is confusing the trailing stop-loss with a fixed stop-loss or a take-profit order. Unlike fixed stops, trailing stops move with the market; unlike take-profits, they don’t close the position at a predetermined profit level but instead adjust to lock in profits as the price advances.

Related Queries
– How do I set a trailing stop-loss on my trading platform?
– What is the best trailing stop distance for stocks or forex?
– Can a trailing stop-loss be used in CFD trading?
– Difference between trailing stop and stop-limit order

In summary, the trailing stop-loss is a versatile order type that helps traders manage risk and protect profits without requiring constant monitoring. It is especially effective in trending markets, allowing positions to run while providing a safety net if the trend reverses. Understanding how to set the trailing distance appropriately and recognizing the order’s limitations are key to using this tool effectively.