What is a trailing stop order?

A trailing stop order is a specific type of stop-loss that automatically follows your position if the market rises, securing your profit, but it will remain in place if the market falls – closing out your position if the market moves against you.

A trailing stop order does not set the stop level at a certain price, but rather at a certain distance away from the current market price. It would be placed below the current market price if you are opening a long position on an asset, and above the current market price if you are opening a short position. A trailing stop is set at a percentage level or certain amount of points away from the market price – this distance is known as the trailing step – and the stop will move to maintain that distance from the current price.

Example of a trailing stop order

Let’s say that you think the DJ30 is entering into a bull market, so you decide to buy it at 26,555 with a trailing stop set at 26,505. This allows the DJ30 to move 50 points against you before the stop closes you out.

Since this is a trailing stop, you'll also need to enter a trailing step amount. The trailing step dictates how much the DAX needs to move before your stop moves with it. So, if you have set your stop to move every time the DAX moves five points, then it will move up to 12,510 when the DAX hits 26,560, and so on.

Suppose the DJ 30 hits a high of 26,610 before retracing – your trailing stop would have moved up to 26,560 and would be triggered if the market fell below this price. When your position closed, you would still earn a profit because your trailing stop has broken even.

If you had used a basic stop on the trade, it would have closed your position at 12,505, earning you a loss.