The Benefits of a Trailing Stop Loss

The most crucial aspect of any trading strategy is identifying the precise risk management technique you want to use.

Before you start a trade, you should always have a clear understanding of where you want to depart and recognize when you are incorrect. What is considerably more difficult is determining when you are correct without leaving money on the table. This is when a trailing stop loss may help.

Not every trading method is aimed toward employing a moving profit point. For example, if you want to scalp the market, you cannot afford to take the risk of eliminating a profit level and hoping the market continues to move in your favor. The same may be stated for a mean reversion approach using a currency pair or index that trades in a narrow range. A trailing stop is ideal for a trend-following strategy that relies on momentum to catch a move.

How to use trailing stop loss?

In general, trend following methods are designed to capture huge movements as a market begins to trend. One of the issues with a trend following method is that establishing whether a trend is in place generally necessitates a lag signal, since the trend must begin before you recognize there is a trend.

The moving average crossover approach is one of the most popular trend tracking tactics. This approach is based on the crossing of a short term moving average above or below a long term moving average. The USD/JPY chart depicts four distinct situations in which the 20-day moving average crosses above or below the 50-day moving average.

The loss with this method is that the signal is often delayed, and if a trend is not there, you will lose money. Because markets only trend approximately one-third of the time, you must earn more money on winning transactions than you lose on losing trades for this method to make financial sense.

The key to a profitable trend following approach is to ride the trend until it reverses. The easiest approach to do this is to cause a trailing stop. A trailing stop is a stop loss that moves with the market.

As the trend takes hold and the market goes in your way you continue to adjust your stop with the market. So, instead of devising a trading strategy in which you expect to win $2 for every $1 you risk.

You set your first stop loss and then adjust it when the market moves. Many traders would wait for a reversal signal to assist them decide whether or not the market's tendencies have shifted. Others may look for a shorter-term moving average crossover to see whether the market has shifted direction.

Using a trailing stop loss with a trend following technique can keep you in the market when it swings in your favor, allowing you to harvest significant profits that will compensate for losses when the security you are trading is range-bound.