What is a Trailing Stop Loss?

Market orders - like the stop loss - are a lifesaver for all kinds of crypto traders. Using features like trailing stop loss can enhance their effectiveness even more. This modified stop-loss order enables traders to set a maximum loss for a position. By knowing how to take advantage of a trailing stop loss order, traders can better protect their gains. 

It might become confusing to tell when you should set up a trailing stop for your crypto trades. In this guide, we’ll share expert knowledge on how a trailing stop works. You’ll also learn what to be aware of when using trailing stop losses.

What is a trailing stop loss and how does it work?

A trailing stop loss is an adjusted type of stop loss order typically used to minimize loss. Traders can use a stop-loss order to

• automatically sell their crypto if or when the asset’s price falls below a certain threshold.
• A trailing stop loss can further modify the typical order to benefit traders on specific positions and allow for more flexibility.

Suggested reading: Stop Limit Order vs. Stop Loss Order: What’s the Difference?

A usual stop-loss order is set at a lower value or percentage than the current market price. For example, if the current market price is $100, then a trader might set the stop loss at $90. They could also input a 10% loss. With trailing stop losses, a percentage is set, and the price is tracked. By adding a trailing stop, traders can stay open on a position for a longer time. 

This is because a trailing stop is designed to protect gains by keeping the position from closing while prices move in the trader’s favor. Traders can set their trailing stop at a lower price if they have a short position.

If they are holding a long position, they can set it to a higher price than the current one. An investor can place their trailing stop loss order simultaneously when they open a trade, or sometime after. 

When to use a trailing stop?

A trailing stop is useful for both long and short-term trading strategies, but it’s especially helpful to day traders. It stops a position from closing too quickly due to short-term price fluctuations, allowing traders the opportunity to turn a better profit. Let’s look at an example of how a trader would use a trailing stop loss for a real crypto position. 

Trailing stop loss example

Our trader named Lucas wants to buy Bitcoin, but knowing it’s a relatively volatile crypto, will use a stop loss order as a safeguard against risk. He decides to buy 1 BTC for $30,000. After reviewing Bitcoin’s historical data and current market sentiments, Lucas decides he’s comfortable with setting a 5% loss. 

He sets his stop loss order at this loss percentage, or $24,500. He goes to his crypto trading platform, creates a new order for his position, inputs all the details, and confirms it. Lucas also wants to keep his position open in case the price moves upward instead of downwards. By using a trailing stop, his stop loss threshold will move in tandem. 

Let’s say Bitcoin’s price increases by $500. In this case, his stop-loss order will also move up $500 to a total stop-loss price of $25,000. 

However, if Bitcoin’s price starts to fall, the stop-loss price will stay the same. In this example, if the price now falls to $25,000, the stop loss order will automatically execute. The system will share a market order for his Bitcoin immediately, and accept whichever price is closest to the current market value. 

Lucas can choose to set his trailing stop to whatever percentage he wants. Most traders will choose a percentage around 10-12%. This is because a smaller percentage could defeat the purpose of the trailing stop. 

On the other hand, a too large percentage wouldn’t properly protect the trade from risk. A price pullback that’s larger than 10% is also much more likely a significant market event, rather than a short-term fluctuation.

The pros and cons of using a trailing stop loss

Pros

1. Improved efficacy of stop loss orders: If you’re planning on using stop loss orders in your crypto trades, why not improve their effectiveness with trailing stops? A trailing stop adds more flexibility to your risk management strategy.
   
   
2. Limit losses: The trailing stop is an add-on to the stop loss order. This means that the original purpose of the stop loss (to limit loss) still works, and will protect traders from losing too much.
   
   
3. Improved gains: One of the biggest disadvantages of a stop-loss order is its potential to close a trade too soon. If a short-term price fluctuation triggers the order, the trader loses out on potential profits. This is because, often, crypto prices climb after a momentary decline. If the trader held their position longer, they could have sold the crypto for an increased price. By using the trailing stop, the risk of this happening lessens greatly. 

4. Data-driven approach: It’s not uncommon for traders to make decisions fueled by emotions like panic, excitement, or even greed. Using your feelings as a guide rather than data, though, can jeopardize your gains. With a trailing stop loss order, traders can rest assured that even when the market fluctuates, your crypto is safe. This gives traders the space to evaluate the performance of their crypto and wait for the order to execute on its own. 

5. Saves time: Many day traders have full-time jobs and invest in crypto on the side. They don’t have the time (or energy) to continuously check on the market’s conditions. Using a trailing stop loss frees up a to check their crypto investments only when necessary.
   
   
6. Cost-effective: Trailing stop loss orders usually cost nothing to implement. Traders can also set them directly through their crypto trading platform of choice. This makes the trailing stop a convenient and cost-effective risk management tool.

Cons

1. Restrictions: If used incorrectly, a trailing stop loss will become restrictive rather than supportive. Without understanding how trailing stops work, such as by inputting too low a change percentage, they could limit efficacy.

2. Difficult to determine: It’s hard to know if your trailing stop is at the right distance. Some traders set theirs at a mere 5%, while others might set it at 20%. Traders can only make an educated guess as to what threshold will work best.
   
   
3. Disrupted by extreme volatility: Cryptocurrency is a relatively volatile market, and when big events occur, it can cause extreme changes. Too big a swing in price might disrupt your trailing stop loss. This can even happen with short-term strategies, like day trading and scalping. Crypto pairs often cycle between lows and highs in a pattern called whipsaw before they settle. When this happens, the price swings can hit and trigger your trailing stop.

Can you lose money with a trailing stop loss and are they a good idea?

Yes, you can lose money with a trailing stop loss, but this doesn’t mean they’re a bad idea to use! Just like every other risk management tool, trailing stops can have some disadvantages. They aren’t guaranteed to lock in your profits or to help you avoid all market volatility. However, their cons are far outweighed by their advantages. 

Traders have used trailing stop losses for crypto and other assets, like stocks, for years. They’re historically proven to act as a great tool for improving profits. To make sure that your trailing stop losses are working effectively, evaluate your currency pairs, current market conditions, and your financial goals. 

Experiment with trailing stops on low-risk trades to familiarize yourself with how they work. By improving your knowledge through articles like this one, you’re sure to improve your chances of success.