Cut your losses short and let your winners run.
This famous piece of trading advice has led many traders to success. It is deceptively simple but can be hard to put into practice.
Cutting your losses short prevents you from losing too much capital and allows you to quickly bounce back even if you have several losses in a row. To do this, exit the trade when the price reaches an invalidation point with an adequately placed stop loss.
Letting your winners run means allowing your winning trades to keep going without closing them prematurely. This can be very tricky for inexperienced traders. Some use it as an excuse to let their greed take over and don’t set any stop losses at all. This means you could lose all of your money from a single bad trade.
So how do you let your winners run without the risk of potentially giving up all your unrealized profits?
One way to do this is to use a trailing stop loss. This is when you are continually moving your stop loss further into profit, thus securing some profits while still giving your position room to keep going if the trade continues going your way.
In this article, we will go over several ways you can implement trailing stop losses to both secure and maximize profits simultaneously.
Fixed Trailing Stop Loss
One common trailing stop loss feature you may find in some exchanges and tools is an automatically fixed trailing stop.
With a fixed trailing stop, you set a maximum distance (percentage or dollar value) between the stop loss and a price level that is further away in the direction of your trade. As long as the price remains within this distance, your stop loss will stay in place. However, when the price would move more than the maximum distance away from your stop loss, the stop loss is moved along with the cost to ensure the entire length is never broken.
For example, let’s say that your asset is trading at $300, and you decide to place a fixed trailing stop at $100 with a maximum distance of 200.
If the price moves up to $400, the fixed trailing stop would be moved up to $200 to keep the 200 maximum distance between the stop loss and the highest point price has reached.
If available as an automated feature, this kind of trailing stop loss is very convenient because you can set it up and walk away.
However, fixed trailing stop losses are not without their drawbacks.
If you set one up while your stop-loss is still not in profit, volatile prices could pull your stop loss up closer to entry and move down to kick you out of the trade with a slight loss or at break-even before moving back into profit. For this reason, it is better to set up your automatic trailing stop only after you can comfortably place your initial stop loss level in profit.
Fixed trailing stop losses could also end up dragging your stop loss up into exposed areas that are not protected by any logical support/resistance levels or other technical factors. This may lead to your position getting closed prematurely, even if the asset looks like it should continue moving in the desired direction.
This is why you may prefer to use more manual trailing stop loss options to move your stop loss into more logical levels.
Moving Average-Based Trailing Stop Loss
Indicators that move along with the price in some way, such as moving averages, Bollinger bands, or the Ichimoku Cloud, can help find dynamic, logical levels to reposition your stop losses.
As an example, we will demonstrate how to trail stop losses using moving averages. Moving averages are dynamic indicators that adjust according to the price and can thus be used as moving points of reference as price develops.
To start, place your chosen moving average onto the chart. If we want to follow the price and have tighter stops closely, we can use a shorter moving average, such as a 20 or 50 MA. If we want an exceptionally loose stop, we can choose a longer moving average, like a 100 or 200 MA.
Whenever you want to trail your stop loss into profit, such as after a big move or after the close of a daily candle, move your stop loss somewhere below the moving average.
There may also be times when you want to split your trade into shorter-term and longer-term positions. To apply this technique to multiple positions, you can place various moving averages onto the chart. Then, use the shorter MAs to trail stops for your short-term positions and the longer MAs to trail stops for your long-term positions.
Candlestick-Based Trailing Stop Loss
Suppose indicators are not available or you prefer to follow price action. In that case, you can also move your stop losses up by counting the closed candlesticks that move toward your trade and moving your stop loss below/above the last few candles (that moved in the right direction).
Depending on how closely you want to follow the price, you can choose to use one, two, three, or more candles.
As an example, we will demonstrate how to trail your stop loss by using three candles. The screenshot above shows a long position. When the price starts going up, you can move your stop loss to the third closed candle that moved in the direction of your trade. As we are going long, only green candles that have fully closed should be counted. Repeat the process until you are stopped out.
If you wish, you can also split your trade into multiple longers and shorter-term positions. Trail your stops using fewer candles for positions where you want to risk less profit and get out quickly, while positions, where you want to stay in the long-term trend can use trailing stop losses that count more candles.
Price Action-Based Trailing Stop Loss
For those who can identify support and resistance areas, it may make more sense to trail your stop losses by moving them to places where other buyers/sellers are more likely to step in and prevent your stop loss from being triggered.
In the image above, price action is used to set a trailing stop for a short position. As the price moved down, a potential area of resistance revealed itself. Moving the trailing stop loss down somewhere above this resistance area allows it to protect your stop if the price tries to push back up.
Keep repeating this until the price comes back up to hit your stop loss.
Trailing stop losses can be powerful tools that help you stay in a trade longer to maximize profit while still giving you some guarantee that your winning trade will remain profitable.
Depending on the asset, your trading style, and your personal preferences, you may find that some of these techniques work better for you than others. You may also decide to use a combination of them, such as trailing stops for a long-term position using moving averages while trailing stops for a scalping position using candlesticks. Experiment with different techniques, record your results, and figure out the best methods that work for you over time.
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