Trading can be a source of income and entertainment, although wise traders use safety mechanisms to protect their trades from unreasonable losses. Trailing stop loss orders are one tool that can be used to protect trades against extreme market fluctuations and limit a trader’s losses to a margin with which they are comfortable.
Determine how to you would like to set up your trade, either by executing your trade through a broker, or setting up your own trades directly through an online system for your own account. Trailing stop loss orders may be set up for trading of stocks, foreign currency or other assets.
Understand the mechanics of a stop loss order. A stop loss order is used during trading as a “safety mechanism” to close trades before huge losses result. A stop loss order is set to close automatically when the security being traded reaches a predetermined price.
Know the price you want to close out your trade at before entering into the trade. This requires doing some analysis of the trading trends and average movements of the asset you are trading, and deciding how far away from the market price or market range you are comfortable setting your stop loss order.
Use the trailing feature for a stop loss order wisely. The trailing feature works well for longer duration orders, and with a trailing stop loss, the execution price is set up so that as the asset price fluctuates, the stop loss execution price adjusts along with it, maintaining a kind of flexible buffer. A trailing stop loss order can be set to execute as a market order or limit order. Market orders execute at the current best price; limit orders execute at a set, or higher than set, price.
Determine the spread for your trailing stop loss. This involves choosing the percentage or dollar decimal amount away from the current market at which the stop loss order will be placed. The stop price will move or “trail” as the market moves.
Determine whether to set a trailing sell stop loss or a trailing buy stop loss order. A trailing sell stop moves the stop loss price up as the stock price goes up; it stays the same when the stock price goes down. Conversely, a trailing buy stop order adjusts down as the market goes down, and stays the same when the market goes up.
Initiate the stop loss order by using a broker or your software trading interface. Alternatively, rather than setting a programmed stop loss order, some traders choose to use a "soft stop." This involves writing a number down that serves as his trading limit for a loss, and manually exiting a trade if the price hits this number. This method works best for traders who watch the market constantly, and who have the discipline to manually execute a stop loss order if the market hits their predetermined number.
Cynthia Gaffney has spent over 20 years in finance with experience in valuation, corporate financial planning, mergers & acquisitions consulting and small business ownership. She has worked as a financial writer for online finance publications since 2011, including eHow Money, The Motley Fool, and Sapling.com. She has also edited for several online finance publications, including The Balance, Opposing Views:Money, Synonym:Money, and Zacks.com. A Southern California native, Cynthia received her Bachelor of Science degree in finance and business economics from USC.