May 31: Trailing Stop Orders in Stock Trading

by David Jenyns on May 31, 2007

In the stock market realm, one way to protect all your gains from purchased stock and to limit the amount of losses is to place a trailing stop order which sets the stop price at a certain amount. If the stock market prices rise, then so does the stop price, however, if the stock market prices decrease, the stop price remains the same. This allows the investor to set a limit on the maximum possible loss he or she is willing to accept, however, the amount of gain is limitless.

Pretend that you have just purchased 100 shares of Company M for $50 per share and you want to lock in the profit but limit your losses so you set the trailing stop 2 points below. Much to your surprise, the price of shares from Company M starts to increase up to $655 during one month. Because you issued a trailing stop order, the price has adjusted just as it should, to $653, which is 2 points below $655. Once it hits $653, the trailing stop order is activated and a market order to sell 100 shares from Company M is placed in order for your broker to receive the best possible price on Company M’s stock. Thus, this works to protect your initial investment as well as to ensure that you will gain a profit.

Because of the way the trailing stop order is set up, you, the investor, do not have to monitor on a daily basis how a stock playing out. Therefore, you are able to simply invest your money by purchasing stock in a company that you feel comfortable with, place a trailing stop order on it, and then sit back, stress free allowing the investment to grow. Also to be noted, the trailing stop order is free to use, so do not allow your broker to forget to mention it to you and do not forget to use this investment option because it is there help you.

However, there is not one particular strategy in place in order to keep a stop price from being activated. It is suggested that if you have invested in long-term stock options to set your trailing stop loss at 15% or more, but if have invested in a short term stock option; you would want to set your trailing stop loss at around 5%. Another restriction on the trailing stop order is that you may not use them on certain stocks, such as penny stocks. The higher the risk on the stock purchase, the less of a chance you will have to use your trailing stop order.

As a final note, only use the trailing stop order when you actually own stock that you feel is about to drop. If a particular stock is about to drop, this type of order ensures that you will be able to sell the stock to ensure that you receive a return in investment. As quickly as the stock market fluctuates, it is important to utilize this type of order, especially on stocks that you have bought, but later feel that they will drop in price when you decide to sell them.

For instance, you bought let’s say you bought stock in a restaurant chain that you felt was going to gain a tremendous amount of profit, however, at the quarterly review of your portfolio, you and your broker discover that your restaurant stock has only gained 2% in four months. This is an extremely lower than the estimated 25% gain that was predicted for this stock. When you bought the stock, you placed a trailing stock order on it in order to prevent your rate of return from dropping. Therefore, you make the decision to sell the stock because, after the consultation with you broker, you feel that the stock is not going to increase any time soon. By placing the trailing stop order on your restaurant stock, you basically ensured that a high rate of return was “locked in” so that you would not lose very much money when purchasing the stock.

Trailing stop orders tend to be a little confusing, however, just know that by placing them on all the stock that you possibly can ensures that you will receive a high rate of return. It’s like an insurance policy on your purchased stocks.

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