What is a Trailing Stop Loss?
A Trailing Stop Loss is a type of order which locks in profits as the price moves in your favor.
It prevents scenarios where a market that had been moving in your favor suddenly reverses back to hit your initial Stop Loss order.
If a market does so, it will kick you out of an otherwise profitable trade, and so a trailing stop loss comes in handy.
In this post, expect to learn how to use the Trailing Stop Loss when trading Forex.
I will teach you the ins and outs of Trailing Stop Losses, so every word in here is worth your time.
Using Trailing Stop Loss When Trading Forex.
Trailing Stop Loss is the tool most traders use to ride big market trends.
There is no need of having a tight Take Profit where a trend has a huge potential of giving you a reward to risk ratio of over 20:1.
Use a Trailing Stop Loss to lock in profits as the trend grows.
But how do you use a trailing stop loss?
I will explain in the paragraphs that follow. Here goes: –
Trailing Stop Loss Based on Moving Averages.
Moving Averages such as Simple, Exponential, and Weighted Moving averages smooth the price and show results in form of a line.
They are therefore suitable for showing current market trends and reducing market noise.
Basically, when the price is above a moving average, the trend is upwards, and when below it, the trend is downwards.
That is to mean that you should ideally be in a buy position when the price is above the moving average and a sell position when below it.
So how do you use moving averages to trail your stop loss?
By exiting the up trade when the price which has been above the moving average closes below it.
Similarly, you should exit a down trade when the price which has been below the moving average closes above it.
That way, you will have locked in profits accumulated in the price move before the price closed on the opposing side of the moving average.
Note this important tip.
Use the 20-period moving average to ride short-term trends, 50-period for medium trends, and the 200-period for long-term trends.
Trailing Stop Loss Based on the Average True Range Indicator.
The Average True Range (ATR) Indicator is a tool most Forex traders use to ride big trends.
How it works is very interesting.
The Average True Range is mostly used to set trailing stop loss with respect to market volatility.
You choose which multiple of the Average True Range you would like to use as your Trailing stop loss and let the trade run.
So what after the Average True Range multiple?
Let’s say, for example, you had chosen a multiple of 2.
For an up trade, the trend will rally upwards, then the trade will close if the price reverses downwards by a value of 2 below the highs of the trend.
For a down trade, the trend will rally downwards, then the trade will close if the price reverses upwards by a value of 2 above the lows of the trend.
Therefore, the higher the value, the more the price will reverse before profits are locked in, and so the less the profits.
The less the ATR value you choose, however, the less the price will reverse before profits are locked in, and thus the more the profits.
An important tip to note is.
An ATR value of 2 is the best for short-term trends, while an ATR value of 4 is best for medium trends.
Use an ATR value of 6 for long-term trends and enjoy the ride.
Trailing Stop Loss Based on Percentages.
Here is another manner you can use Trailing Stop Loss to lock in your profits.
This is by setting percentages rather than absolute values like the previous method.
What do you do here?
Some Forex trading platforms avail traders an automatic Trailing Stop Loss which is based on percentages.
So you only have to enter a position, then apply a Trailing Stop Loss at say 10%.
What a Trailing Stop Loss at 10% means is simple.
For an up trade, the trend will rally upwards, then the trade will close if the price reverses downwards by 10% below the highs of the trend.
For a down trade, the trend will rally downwards, then the trade will close if the price reverses upwards by 10% above the lows of the trend.
Still don’t get it?
Say for example you bought a stock at $100, then its price rallied to $50.
The up trade will close if the price reverses downwards by 10% of the gains. What is 10% of $50? $5 of course.
The higher the percentage, the more the price will reverse before profits are locked in, and so the less the profits.
The less the percentage, however, the less the price will reverse before profits are locked in and thus the more the profits.
Want some pro tip?
You can use 10% for short-term, 20% for medium, and 60% for long-term trends.
Stop Loss Based on Price Action.
Let us assume that you are already in a trade.
The price has moved in your favor and is now wondering where to take your profits.
You can use price action to lock in profits.
Did you just ask how?
Let’s say you are in an up trade and the price has rallied up so significantly.
Just identify a recent swing low.
You should exit your buy trade when the price closes below such swing low.
What about a down trade?
If the price has moved downwards in your favor, just spot a recent swing high.
Close your trade when the price closes above such swing high.
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