Questrade.com | Trail stop order | Watchout and tips

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When using trailing stop orders to buy or sell shares, there are a few key things to watch out for that can impact your order. We’ve summarized a list of watchouts & tips in this section below so you can familiarize yourself with all the ins and outs of trading with trailing stops.

Please note: The information prepared in this section is for educational purposes only, and should not be taken as any form of trading or investment advice.

Trailing stops come in 2 varieties:

‘Normal’ trailing stops are also known as trailing stop market orders. This is because once a trade in the market takes place at your trigger or offset price, then a market order is sent to the exchange. Due to this, your order may not execute exactly at your trailing price, but rather at the best available bid or ask. This can be a concern if the security you’re trading experiences large fluctuations in price very rapidly (high volatility), or trades in low volumes with ‘wide’ bid-ask spreads.

Trailing stops also exist as limit orders, these are known as trailing stop limits. With this type of order, in addition to setting a trigger-stop price, you are also setting a specific limit offset (which determines the limit price). Once your trailing price (trigger) fills, a limit order is sent to the exchange at your specific offset.

Both trailing stop market and limit orders have their upsides and downsides. For securities dealing with high volatility for example, a trailing stop market order may not execute at your preferred price.

And for example with a trailing stop limit order, if you’re looking to sell shares at a specific price, you run the risk of your trail being triggered, but then if no trades take place at your limit price, your order will not fill and execute.

Price gaps

‘Gaps’ in price action for stocks and other securities can happen during times of high volatility. A gap in price is when the previous day’s closing price is significantly higher or lower than the start of day price, and there’s a ‘gap’ where no trades have taken place between the 2 prices.

For example: ‘XYZ’ closed yesterday at $20 a share, but after a poor after-hours earnings report, on the following day the first trade at market open is significantly lower at $16. No trades have taken place between $20 and $16, the price simply ‘gapped down’ due to the poor earnings report the previous day. If you own shares of XYZ, and are using a trailing stop sell order as downside protection, this gap in price can have a significant impact.

For example: let’s say we had a trailing stop order placed on XYZ with a $2 offset. If XYZ was trading at $20 when we placed the order, our offset or trigger price is $2 lower at $18. If XYZ ‘gaps down’ in price to $16, and no trades have taken place at our trailing price of $18, our order will trigger much lower than intended.

Your trailing stop sell will trigger if trades have taken place at your stop price, or below. At which point it becomes a market order, and can result in an undesirable execution price.

Choosing your trailing or trigger price

When trading with trailing stops, it’s important to think about your specific trailing price or percentage. Using a trailing stop that’s too “tight” or close in price to the market price may have the unintended consequence of being triggered by normal daily price movements, causing you to miss out on potential gains if the price continues to climb. However, setting a trailing stop that’s too “wide” or far away from the market price, may lead to unnecessary losses before the order triggers.

For example: suppose you own shares of XYZ trading at $20 per share, and would like to use a trailing stop sell order to protect your investment. If you see that XYZ regularly ‘pulls back’ by 2-3% before moving higher again, we can use this information to help us make a more informed decision of what trailing percentage to use.

In this example, a 1-2% trailing percentage may be ‘too tight’, as this can be triggered by minor pullbacks in price. But choosing a 10% trailing stop may be excessive, or ‘too wide’. Since you would have to wait for XYZ to drop an amount far beyond what you have decided is its standard characteristic movement before your order was triggered, it’s possible that a large price drop will cause you unnecessary losses.

In this example, an appropriate trailing stop percentage could potentially be in the 4-8% range. This allows for the security to trade in its ‘normal or average ranges’ while also protecting your order from an unexpected drop in price.

Important to know:

• A trailing stop order is triggered by the last trade, not the bid or ask price.
• The duration ‘GTEM’ (Good ‘til extended market) cannot be used for trailing stop orders or trailing stop limit orders.
• Trailing stop orders only execute during normal trading hours between 9:30am and 4:00pm ET. Pre and post market price movements will not trigger a trailing stop.
• Trailing stop orders are not allowed on Canadian exchanges, only trailing stop limit orders.
• For trailing stop limit orders, there is no maximum allowable spread between the limit offset and the trailing stop price for the U.S. markets, but there is a maximum of 9% allowable spread between the limit offset and trailing stop price for CAD markets.
• Setting your stop price above the current market price of the stock (when selling) or below the current market price (when buying) will cause the order to fill immediately.
• Trailing stop orders are not a guaranteed method of stopping potential losses.