Many traders attempt to lock in profits as the market moves in their favor by trailing the market with various trailing techniques. Personally, I use trailing stops every time I trade a trending based system. When these trailing stop strategies are used correctly, they manage the stop loss level such that they convert floating profit into 'earned' profit. Trailing stop by its nature have these two features in-built.
1. Pip Protection Mechanism
Shifting of this stop loss level for the purpose of locking in earned pips acts as the pip protection mechanism and secure your profits even before a forex trader closes the trade. In addition, it provide a plan for traders to exit their trade when the trending market become exhausted.
2. Pip Maximization Mechanism
A trailing stop will exit the trade when it detects that market has some form of trend exhaustion while at the same time maximizing the potential of profit from a trend. This is what we called pip maximization mechanism.
However, when trailing stops are not used properly, a trader will end up adding volatility to his results in terms of risk to reward ratio and return of investment. This is because using trailing stop will some time allow the trade to exit prematurely due to noise resulting in a stop out. After a stop out occurred to a trade, price seems to consolidate and continue trending again.
The value of a trailing stop order is obvious. Because it prevents the forex trader from leaving after achieving a small profit, he will have a plan to ride a trend for as long as it is profitable. He will only leave when trend exhaustion is detected as market goes into consolidation phrase and no more opportunity to capture more pips from the trend.
While trailing stop has their limitations, we believe that their advantages outweighs their limitations and it is very important for beginning traders to apply trailing stop strategies to their trading system where they are just starting and have not have a solid plan for risk management. Trailing stop provides the discipline and a plan for traders to exit and cash in their profits rather than risk having to give back to the market.
There are many techniques to manage a trailing stop. Traders often start moving their stop when their positions have earned twice the amount risked. Another popular technique is to trail the market with a stop placed near the high or low price over the last 2 candles. Both of these techniques are effective for short-term trading or otherwise called intraday trade.
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