Trailing stop orders
Trailing stops are my favorite investing tool. The trailing stop allows an investor to sell a stock after a drop of X points, set by the investor. The trailing stop is a great way to lock in profits and avoid runaway sell offs. Trailing stops are very common in forex and futures trading and have recently made their way into popular equity platforms.
In example:
Lets say I buy a share of Yahoo, which trades at $30 per share. I set a trailing stop of $5, meaning my stop loss sits at $25. Then Yahoo moves to $33 per share, moving my stop loss up to $28 per share. As the stock moves up my stop loss follows, but when the price falls, the stop loss does not move. If Yahoo were to dive to $25 per share from $33, I would automatically be sold out at $28. However if the stock moved to $40 per share, then back to $35, I would be immediately stopped out at $35 per share, locking in a $5 per share profit.
The trailing stop can take a lot of tinkering as well. It is important not to set your trailing stop too small, in order to keep your positions open longer than just a few seconds. I suggest setting a 10% trailing stop for short term positions, after 10% you need to let the losers get cut and you’re still going to profit from large moves forward.
For the long term investor the trailing stop doesn’t serve much purpose. Rarely should a trailing stop be set when an investor has a long period of time to make a return on his or her investment. The trailing stop is the best way to cut losers short and let the winners run. The old adage is to cut a position after an 8% loss, the trailing stop makes implementing this advice that much easier.
