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Trailing Stop Order Basics

Trailing stop orders are a form of stop loss orders. Their major purpose is to protect the profit from a stock. If used appropriately, trailing stops can follow an increasing price of a stock.

Protection from a Loss

As we mentioned above a trailing stop order is a type of a stop loss order. Under the latter, you set a price level, which if reached turns the stop loss order into a market order and requires your broker to sell the particular stock immediately. The selling of the stocks is executed at the best price currently available.

Stop loss orders are used as a way to minimize losses from falling prices of stocks.

Profit Protection

Stop loss orders can be used to protect your profits as well.

Generally, there are two ways in which you can structure a stop loss order. One of them is through the setting of a dollar amount, which is lower than the price at which the stock is currently traded. Once this price is reached, the stop loss order is turned into a market order, which requires the broker to sell the stock.

On the other hand, you may have purchased a winning stock whose price is rising at a steady rate. However, every investor knows that after each increase a fall in the price may follow.

Once you have sensed that the price may fall, you face several options. One of them is to sell the stock and move away with your profit. The other option is to wait awhile since the stock may have some way to go until it starts to fall. When you decide to do this you can set the price level in the stop loss order by setting it as a percentage below the current market price. If you choose this way of price setting you are using a trailing stop order.

Example: The current price of a stock is $40. You have instructed your broker for a 10% trailing stop. Thus, the trailing stop order will be activated if the market price is $36 per share ($40 - 10% of $40).

The trailing stop moves in accordance with the price increase. For instance if the price increases to $44, the trailing stop will be $39.6 ($44 - 10% of $44).

The trailing stop order has no effect if the price of the stock keeps rising or stays at the same level. On the other hand, if the price of the stock falls, the trailing stop order is triggered when the specified level is reached and your broker is required to sell the stock.

You should remember that trailing stops go up only. They don't follow the price if it falls.

When selecting the percentage of the trailing stop you should select a level which is not influenced by the normal fluctuations of the market.

Final Piece of Advice

Trailing stops can be used in a combination with other techniques in order to provide for a greater protection of your profits. If you are a beginner or an intermediate investor it is recommendable to include a trailing loss order as part of your investment strategy.

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