What is a trailing stop? (July 1, 2000)
A trailing stop is a stop loss or stop limit order that moves up behind your position as the price rises. It would be great if you could have a program that would automatically move the stop up every time your stock or option moved up $2, $4, or whatever level you set it. We have yet to see such a beast, but it is just a matter of time; there used to be no stop losses at all on options.
In the interim, it is just plain old hard work on the investor. We have to keep track of our positions, and we tell our brokers how to move the stops up. On some stocks we have a greater leeway depending on the stock and on our longer term objectives with the position. Same thing with our option positions. What we often do is tell our broker that on the XYZ play, whenever the stock/option price moves up $3, move up the stop $3 (or $2 or whatever we feel comfortable with on that position). Usually it is a dollar for dollar move if our objective is to maximize the profit without chancing much downside. When markets are choppy as they were a month ago, we would move them up right with the stock or option as it rose; with the major swings back and forth, we did not want to lose our profit in one afternoon. We would rather bank the profit and look for that play or another play once again.
Friday we were taken out of our JNPR positions. The stock received a reiterated 'strong buy' recommendation in the morning, but could only manage a $2.50 pop on the news. We figured after two huge days the stock would be tired. When the news did not send it up $5 or more, that confirmed in our minds the stock may sell back. We made the decision to sell if the stock started dropping and then get back in when it turned back up. With options we often do that, especially if the positions are just a month or two out. The logic is we will back some profit instead of riding it down and looking for another move up. If the move back up occurs, we can get back in and ride the move again without having to make up lost ground. Given the stock's action, we moved up the trailing stops on our options to 34.50. If JNPR kept on climbing, we were golden. If it sold, we locked in the profit. JNPR ended up tanking $10 before rallying late in the day. We locked in some great profit (bought the options at 20.62 on 6-20), and we were back in the stock when it started racing back up that afternoon. It is a leader we want to be in on when it pulls back and starts back up, just as it did Friday. This was another use of trailing stops to capture profit when you were willing to sell, but not certain if the stock would keep on running up.
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