How do you use "Trailing Stop-Loss" techniques? (December 23, 2000)

  A trailing stop loss is a stop loss order that is moved up behind a stock or option as the price increases, hence the 'trailing' label. There are two ways we know of doing this: yourself or if you have a good broker. Often what we do when we enter a position and are not going to be around to watch is tell our broker as the stock or option moves up, move the stop loss up behind it up as well. When first opening a position, this is easier for stock as the spreads are usually smaller and you don't have to make the larger option spreads. If you have a $1.50 spread on options, if you want to stay $1 or $1.50 behind the option price, you have to overcome that spread. After the position moves up, that is not a big deal. You cannot always get a broker to mind positions that closely; good brokers have a lot of clients. Some have systems with alarms they can set, and that helps them track positions. If things get busy, one broker cannot always keep up with all instructions. So, we usually call when we have a chance and say go ahead and move the stop loss up. This way we can follow gains up. We may get stopped out on intraday pullbacks, but in this market that is a risk usually worth taking.

The next issue is how close do you put the stop loss. That has to be personal taste. At first we don't put it too close, particularly on options. We want to give the play a chance to work. Once it starts moving up well, then we make the first move up, usually below a point where we think the stock might come back and test. As we often demonstrate, stocks come back to test their first big moves of the day, and we don't want to get taken out on that move. That could be the open price a resistance point it broke above. After that test, we will start moving up the stop loss to literally trail the stock or option as it goes up. The stock's volatility is our guide. If a stock is trading in $2 increments up and down as it trends up, we will drop the stop back a little over $2. Many times after a stock or option logs a good gain that we are happy with and don't want to lose we will throw calculations out the window and set a stop where we are comfortable with the profit we will make if stopped out. At that point we always struggle with the choice to just sell the option outright or put in a stop and chance less profit. If the market is running as it was today, we will put in the stop and see if the stock or option rises more, giving us a chance to capture more gain. Look at Friday's 'Team Trade' for an example of how this works in practice.

See also:  What is a trailing stop?  How do you figure where to put trailing stop losses? Do you use one of the moving averages?  Regarding stop orders, I have been told that if I place a sell stop order, the market makers may "dip" down and take me out of my position even though the bid may be higher. Because of this, I haven't placed official sell stop orders, yet because I haven't, I have lost more money on some trades than if I had placed the orders. Also when do you use sell "stop orders" vs. sell "stop limit orders"?

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