What Is a Trailing Stop

A trailing stop is a type of stop order that uses a 'trailing amount' instead of a fixed stop price. The trailing amount is set as an amount (points) or a percentage (%).

According to the SEC, for a sell trailing stop, when the price rises the stop price follows up by that much, and when the price falls the stop does not move and stays put. Then, when the price hits the stop price, it triggers as a market order.

In a word, it is 'a stop-loss line that follows in only one direction.'

Say you buy at $100 and set a trailing amount of $10.

1. If the price rises to $130, the stop rises to $120 ($130 - $10). 2. If the price then falls back to $120, it is liquidated, locking in a gain of $20 per share. 3. Conversely, if the price drops to $90 from the start, the stop is triggered at $90 ($100 - $10).

The structure raises the stop to follow gains as the price rises and gives back only the set amount when it falls.

A trailing stop has the advantage of preventing 'a large gain from turning into a small gain or a loss.'

But the risk is clear too. If you set the trailing amount too tight, the stop keeps triggering on normal swings (volatility), causing frequent liquidations (whipsaws). Set it too wide and you sell only after taking a large decline in full.

Also, once triggered it executes at market price like a stop order, so in a plunging market slippage occurs, selling below the stop price. There is no right answer for how large to set the trailing amount, and this article does not recommend any specific value.