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Trailing stop-loss and trailing stop-limit orders are advanced order types that automatically adjust according to a security’s price movement. Learn all about these advanced order types.
A trailing stop order is a type of conditional stop order that is set to trigger at a specific percentage or dollar amount away from a security’s current market price. Trailing stop orders can be entered by themselves for either long or short positions, but are also commonly used in bracket orders.
Trailing stops can also be entered as stop limit orders.
Please note: Trailing stop and other more advanced order types and durations are only available through the Questrade Edge Web and Edge Desktop platforms.
Trailing stop sell orders can be used to restrict potential downside, without capping potential gains. This is because as the security’s market price moves up, the stop order ‘trails’ the market price by a specific dollar amount or percentage.
Trailing stop buy orders can also be used in short positions, they just work in the opposite direction: the ‘trail’ is above the market price, rather than below it.
How trailing stops differ from ‘regular’ stop (loss) orders
Suppose you buy shares of company ‘XYZ’ at $140/share, and would like to use a stop-order as ‘downside protection’ in case the price of the security falls.
You could use a ‘regular’ stop-sell order at a specific set price like $125, but then if the price of XYZ moves up to $160, your stop order will stay at $125. This causes extra work for you to constantly modify your existing stop order and move it up ‘manually’ to continue limiting losses, while maximizing gains.
If you don’t modify your stop order, and move it up from $125, and the price falls from $160, with this strategy, you could lose out on the potential gains from $140-$160.
This is exactly where trailing stop orders come in, and can help you ‘automate’ parts of your trading or investing strategy.
Let’s check out how a trailing stop works:
Sticking with this example, if you bought shares of XYZ at $120, you could enter a trailing stop order to sell your shares with a specific price, or percentage offset. This offset determines how far away the stop order trails the market price. If we set the offset to $10, this would mean our stop order ‘starts’ at $110. If XYZ falls by our offset amount ($10) at any time after placing your trade, our sell order will be triggered.
If XYZ moves up to $130, our trailing stop order will also move up to $120 ($10 offset).
If XYZ continues to increase in share price to $150, our trailing stop will also move up to $140.
Once the share price has risen to $155, if it drops suddenly by $10 or more (our offset amount), our trailing stop would trigger at $145, and a market order would be sent to sell the stock.
Just like a regular stop order (also known as a stop-loss, or sometimes a stop-market), a trailing stop order becomes a Market order once the stop is triggered. This means your order is executed at the best available Bid or Ask at the time. Due to this, your order isn’t necessarily executed at your exact stop or trigger price.
In the previous example, if your trailing stop order was triggered at $145, your market sell order will fill at the best Bid (I.e. $144.97). This depends on how many shares are being traded (Volume and liquidity) and how rapid the price changes are (volatility). In a fast moving volatile market, or for securities that trade in low volumes with wide bid-ask spreads, this can lead to an undesirable order execution price.
This is where trailing stop limit orders come in
Due to this uncertainty in ‘fill’ or execution price, some investors use a Trailing stop limit order. With this type of trailing stop, a limit offset is entered in addition to a ‘trigger’ or stop price. The limit offset/price is what is sent to the exchange after your stop price is triggered. Keep in mind that depending where you set your limit offset, prices may gap past it in fast-moving markets.
The limit of a trailing stop limit order is set as an offset from the trailing stop, either by dollar value or by percentage.
So, for example, if you have a $100 share with a trailing stop of $10 and a limit offset of $5, and the share price dropped immediately, it would trigger at $90 with a limit price of $85. However, if the price jumped to $120 before dropping, the stop would trigger at $110 with a limit price of $105.
Percentages work the same, only the difference is a percentage of the price instead of a static number. In the above example if your $100 per share security had a trailing stop of 10% and an offset limit of 5%, it would still trigger at $90 ($100 - 10%) with a slightly higher order of $85.50 ($90 - 5%). However, if the price jumped to $120 before dropping, the stop would trigger at $108 ($120 - 10%) with a limit order of $102.60 ($108 - 5%).
To learn more about the difference between a stop order and a stop limit order, see our article on stop limit orders.
Let’s take a look at another example using a percentage offset:
Suppose you’ve bought shares of company ABC at $50 per share and would like to use a trailing stop as downside protection. You enter a trailing stop sell order with a 10% offset (trigger price). If ABC continues to trade at $50, your stop or ‘trigger’ is currently set to $45 (10% offset).
If ABC moves up to $70, your trailing stop would also move up to $63 ($70 - 10%). But if ABC then declines to $65, your trailing stop would stay at $63. Trailing stops only move in one direction, so once the shares drop by 10% from any new ‘peaks’ in price, the shares would be sold.
In this scenario, rather than continuing to drop to $63, instead our shares of ABC increase to $80 per share, before suddenly dropping to $70. What price would our sell order trigger at? In this case, it would be $72, which is 10% less than the ‘peak’ or high price of $80.
This demonstrates how trailing stops can be used as an effective tool to help ‘automate’ parts of your investing strategy. You can create a ‘set-it and forget-it’ solution that essentially monitors your positions and sells accordingly. But with any strategy, there are always downsides. We’ll cover some common watchouts and tips in the sections below.
Please note: Even though trailing stops, and other stop orders can act as downside/upside protection, we highly recommend keeping an eye on your active positions and orders. There are a number of reasons an order may be cancelled including:
- GTC orders expiring at the 90-day mark
- Corporate actions, such as:
- Mergers and acquisitions
- Splits, or reverse-splits (consolidation)
As with any trading strategy, or order type, we highly recommend monitoring your positions regularly. This is especially the case for very volatile securities, or securities undergoing corporate actions.
Reminder: This article is for educational purposes only, no information contained here should be taken as any form of trading or investment advice.
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