Trailing Stops – When Should You Use Them in Your Trading?

Posted in: Advanced Trading Strategies, Trading Article

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Trailing your stop loss in the market in the hopes of making big profits isn’t always going to be the best thing to do in every situation.

Markets which aren’t trending (and most of the time, most are not) will come back on you and take you out for a much smaller profit than you might have taken otherwise; the losses however, remain the same.

But with a little bit of common sense and a reasonable amount of practice, it’s possible to apply this sort of technique without the need to increase the amount of risk on winning trades when the context of the situation is right. Trailing your stop loss for bigger profits  is exactly what you need to do in these circumstances.

So when should you trail your stop loss and look for larger gains by riding the trend?

 

Best Time To Trail Your Stop Loss

It’s not always going to be the best idea to go for the home-run trades, but you know they do exist so it’s worth putting in a bit of work to figuring out the best way to attempt to capitalize on any scenarios where the potential for one can happen.

A home-run trade can be tricky psychologically though.

You must remain focused on the standard trading strategy trades and not get carried away into thinking you can pull a big trade out of the market every other trade. That said, if you’re sensible and grounded about it, a few big trades here and there can really give you a fantastic platform to build on.

There will be times in the market that through technical analysis for example, the market may be hinting that a move is coming near.   You can use a news release as another example especially when the release is a surprise in comparison to the expectation.

If we focus on a technical analysis outlook as part of our trading strategy, we can forget about the news and just focus on price.

Trading Range With Higher Range
Trading Range With Higher Range

Consider we have a market in an uptrend and eventually turned into a large trading range.  We can consider any market to be in a trading range when it ceases to make higher highs and lows or lower highs and lows.

The key is to see the right side of the chart where the price movements are showing a higher range under the resistance level.  You can find this pattern on any time frame which makes it a good price pattern to watch for if you are a day trader, swing trader, or even a position trader.

What we have is bulls and bears in equilibrium until the right side where the bulls appear to have the upper hand.  We determine this through the placement of this range as well as the inability of the bears to mount any offense to the lower part of the range as they did in the past.  This pattern tilts the probabilities to an upside break of the resistance zone.

If you’re willing to do the background context work in trading and have a plan to trade it when the market is giving you a strong indication of what it’s likely to do next, there’s no reason why you shouldn’t be able to capitalize safely on it when it does make the move.

 

Risk Free Trades Are The Goal

Incorporating a looser trailing stop in these instances can give you the opportunity to capture a much bigger than normal profit on a trade. However, given that the outcome of no trade can be known beforehand it’s of paramount importance to address risk in order to cover yourself when you are wrong and to maintain control when your position is in profit.

Being able to run a multiple position strategy if done correctly, allows you to manage your risk throughout the trade. As more of the position is scaled out of, the risk of a profitable position turning negative diminishes greatly.

This principle can be applied to the situation where you don’t know how far a market is going to go in your favor and so you ride the trend by trailing a stop in order to capture larger profits and reduce risk on the trade. By taking something off the table early on in the trade, you give the trade a solid footing.

If done correctly, the trade can become virtually risk-free at this point, leaving the remainder of the position plenty of room to handle the ebb and flow of a trending market.

 

Reducing Position Is Managing Risk

Risk is not just about how large your initial stop loss is and how often it’s hit, it’s also about management of profits before you close the trade off completely at a profit target or trailed stop loss.

If you have a strategy where your initial stop is normally around 10 ticks yet the market price is now 30 ticks up with a trailing stop at 20 ticks, your risk is elevated. By reducing the position size on the trade, you can actively manage this element of risk.

Yes, you might not be taking as much on your winning trades, but what you are doing is protecting your trading account when the losing trades would otherwise occur or ensuring some level of profits depending on the stage at which the trade is.

There are just a few of words of caution I have for anyone who wants to trade in this way.

  1. Letting the market tell you when it’s ready to move is massively important. Getting one or two big moves under your belt is great, but every opportunity is different from the last. While it might be frustrating when you see a potentially huge trade disappear before your eyes, it’s imperative that you act based on what the market is telling you it wants to do and rather than on what you hope it will do.
  2. What about that annoying situation where you miss a trading opportunity? Either you didn’t see it soon enough through lack of concentration or perhaps you didn’t have the confidence to pull the trigger.If you get into a trade after price has moved too far from your ideal entry, you have increased the risk . Don’t worry about the trade . Let it go.
  3. It’s important to go into a trade recognizing that you will never  capture all of a move. If you hold on to a trade too long and beyond what you’ve planned for or you re-enter a completed trade because you think there’s more in the move, you’re increasing your risk or even worse you’re entering into a situation where you haven’t identified what your risk is at all. Being happy with what you’ve got, reset and wait for the next trade.

What is important to understand is that any strategy and its management should be grounded in logic, reason, and back testing. If you can tip the odds in your favor by recognizing when that logic and reason is most likely to hold true, you’re in the best possible place to capitalize on your strategy.

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