A question I often get is about trailing stops. People understand they’re a popular exit strategy. But they’re not sure how to apply them to their own portfolios. Don’t worry if that applies to you. This video is going to explain exactly what to do. And I’ll show you examples of how it all works. By the end of the video, you’ll be ready to put the strategy into action.
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So what is a trailing stop? Well quite simply, it’s an exit level that that automatically adjusts as the price of a stock rises. The aim of the strategy is to protect a large portion of a trader’s gains, while at the same time keeping upside open. The trailing stop essentially guides you from the start of a trade to the finish.
Let me show you what I mean:
This is a chart for Bravura Solutions — a financial services IT business. But it really doesn’t matter what stock you own, a trailing stop can be used in just about any situation.
Okay, so do you see the red line below the share price? It looks a bit like a rising staircase. That’s the trailing exit stop. Now, a trailing stop is a simple concept to understand. It’s all about maximising upside by letting profits run, and then exiting stocks when the trend appears to be over.
Think of it like this: All is good while a stock’s price is above the red line. You only sell when the shares dip below it. The red line helps guide you through every trade. Of all the exit strategies I know, the trailing stop is my favourite — by far.
And the best bit, it’s one that you can readily use yourself… there’s no need for special software, and you don’t have to be especially good at maths. You could manage a trailing stop strategy using a calculator and some basic price data.
The key to using this strategy is to decide how far to let your stop “trail”. Short-term traders typically set their stops closer to the share price, while medium to longer-term strategies use a wider exit stop. It’s important that you’re clear about your goal. If you want to target triple digit gains, a close trailing stop typically won’t work.
I’ll give you an example… let’s say you’re a medium-term trader — a typical winning trade could last for a year. This requires a trailing stop that gives your stocks plenty of room to move.
Now, suppose you place the following trade:
You buy shares in Newcrest Mining at $21.78 as the share price breaks upwards. You then set your trailing exit point 20% below the buy price, at $17.42.
Now, this is how you get your exit to “trail”… you simply recalculate the exit point every time NCM makes a new high. So when the shares reach $23.94, the stop will be 20% lower at $19.15. When the stock hits $28.76, the exit will be at $23.01. And from the $38.87 peak, the trailing stop will rise to $31.10.
If the shares are trading sideways or pulling back, then you do nothing. The trailing stop only rises when the shares reach a new high. It’s as simple as that. A trailing stop is a great way to give your trades direction. It marks the way from start to finish. If you like the idea of following a path, a trailing stop could be perfect for you.
I’ve set a 20% trailing stop in this example. But you can use any figure you like. For instance, some people like to set stops closer to the market price. While others prefer to give their trades more breathing space. The choice is yours. But remember, the how close you set your trailing stop will largely be determined by what you want to achieve.
Generally, I believe anything from 20 – 30% is suitable for medium-term trend trading. This gives a stock room to move sideways during pauses in an uptrend. Without breathing space, there’s a good chance your stop will trigger on a minor or moderate correction. And if that happens, you’re out of a potentially highly profitable trade.
Now, take another look at the chart for Bravura:
At first glance, the exit stop broadly rises with the share price. But if you look closely. You’ll notice the stop doesn’t move in lockstep like the Newcrest example. There are times when the shares make a new high, but the trailing stop doesn’t move.
So why is this? If the trailing stop is a percentage of the recent high, you’d expect it to move consistently with the share price. But what you’re looking at now is a variation of the strategy. This is how many professional traders use a trailing stop.
The trailing stop you saw earlier uses the fixed percentage method. This is both a popular and effective strategy. It’s also one of the simplest to calculate — you could do it yourself from home. The trailing stop in this example requires a bit more work. It includes a stock’s recent volatility as a key input. The aim is to tailor the trailing stop to each trade. I use this method myself and it can make a real difference to outcome.
Do you want to know how much difference it could make?
Well, that’s a topic for next week. It’s way too much to get into now. But I will say this… the method I’m going to tell you is unique — you won’t find the same calculation anywhere else. And you’re going to get the inside scoop on how to calculate it.
To get a notification of its release, make sure you hit the subscribe button below and click the bell icon. You can also get a free strategy report from my website www.motiontrader.com.au And if you enjoyed this video and thought it was valuable, then please click the like button and share it with your friends. Thanks for watch, I’m Jason McIntosh, and let’s find some trends this week.