Financial Trading Patterns #8: TRAILING STOP SELL
Nov 30, 2011 at 5:26 pm in Orders by
In this article I describe a financial trading pattern that is motivated by a failure scenario of the STOP BUY, STOP SELL pattern.
NAME
TRAILING STOP SELL
DEFINITIONS
A TRAILING STOP SELL order is an order to SELL a security when the price falls by a specified amount below the prevailing market price. A TRAILING STOP SELL tracks a rising price.
PARAMETERS
STOP SELL Trigger Distance.
OBJECTIVE
The objective is to sell at a high price at the onset of a downtrend.
MOTIVATION
One of the failure scenarios for the STOP BUY, STOP SELL pattern was as follows:
When we set a STOP SELL below the current price, the price might rise significantly, not triggering our order. If the price subsequently falls all the way back up to our STOP SELL level, we sell-out having missed the additional profit potential of the rise-and-fall. In other words: although we have sold on a downtrend, we have sold at a lower price than necessary.
SUCCESS SCENARIO(s)
The following figure shows the success scenario in which the TRAILING STOP SELL helps us to sell on a downtrend, at a high price. With the price trending up, we place a TRAILING STOP SELL order with a trigger price below the current price. As the price rises, the TRAILING STOP is adjusted upwards at the same rate. At some point the trend reverses sufficiently to trigger the STOP SELL.
You might remember that something similar was demonstrated in this article. Technically it wasn’t a trailing stop in that article because we placed a second STOP SELL order at the higher price, rather than adjusting the original order upwards.
FAILURE SCENARIO(s)
The failure scenarios for this pattern are the exact mirrors of those for the TRAILING STOP BUY, i.e.:
- The price rises dramatically soon after the STOP SELL order executes, so we sold out too soon.
- The STOP SELL order executes at the original trigger price soon after we place it, without rising first, and then the price rises dramatically.
APPLICATION
Some stockbrokers and spread betting companies provide a dedicated trailing stop facility that fully automates this trading pattern. In this case you would specify an amount by which you want the price to fall before the order executes.
If your provider does not offer trailing stops, you can still trail the stops yourself by adjusting the trigger price of your non-trailing STOP order periodically, in line with the rising stock price. Some traders will prefer trailing their stop orders manually because this allows them to consider other factors such as technical support and resistance levels.
This article has been devised and adapted from original text and pictures included in the book “Financial Trading Patterns” by Tony Loton (with permission).