Definition of Trailing Stop

What is a trailing stop? What is the definition of the term trailing stop?

In order to define this term, we need to break down the meaning of a "stop loss" first.

A "stop loss" is when you will automatically exit a position after having incurred a predetermined level of losses.

For instance, let's say that you buy MSFT at $50. In order to protect yourself from steep losses, you elect to set a stop loss at $49. This means that if MSFT hits $49, then your stop loss will kick in and you will automatically sell your position.

A "trailing stop loss" is different.

With a "trailing stop loss", the stop loss will be a fixed % or $ loss amount that will adjust as the price of a stock adjusts.

For instance - let's say that you set a "trailing stop loss" of $1 on MSFT, and you decide to buy at $50.

If MSFT trades down to $49, then you will stop out at $49, just like in the original stop loss example.

However, if MSFT immediately trades up to $52, then your "trailing stop loss" will adjust to $51. So, if MSFT falls to $51, then you will stop out for a profit of $1 per share.

You can also set a "trailing stop loss" as a percentage. You would be telling your online brokerage software "if XYZ falls X% from its current level, then you will automatically exit my position with a market order".

Trailing stop losses are a great way to participate in the upwards move of a profitable position while still locking in some of your profits.

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