Using trailing stops is a way to reduce risk, eliminate risk and lock in profits once the triggered trade goes in your favor. There are many different strategies you can use to determine when to move your stop and trail price action. In this post, I want to go over two trailing stop methods: the X Pip Trailing Stop Strategy and the Fractal Trailing Stop Strategy.
X Pip Trailing Stop Method
This is a simple strategy where a specific number of pips is specified to trail price on the close of the next candle. Each close of a candle results in a potential movement of the stop loss in the direction of price. If price does not close in favor of the trade, the stop loss remains at the same level. It is easier to see what I am talking about through an example.
In the photo you can see a sell trade on the EURUSD Daily chart with an initial 100 pip stop loss. If you were using a 100 pip trailing stop, you would move the stop loss in the direction of the trade each time the close of the candle is lower. Each time the candle closes lower, the stop is moved to 100 pips away from the close price.
In this example, the stop has already been moved 6 times and has locked in 216 pips of profit. From the look of the current candle, the stop loss will be moved again after the close of the day. This will keep going until price retraces and takes the stop loss out, or until the final target is hit if you are using one.
Important: If you are familiar with the trailing stop feature inside Metatrader4, you should know the X Pip Trailing Stop Strategy described above is different. The MT4 trailing stop feature would follow price by 100 pips, only in the direction of the trade. This means the stop loss is calculated from the low of the candle and not the close of the candle. This is very different, and in my experience can lead to being stopped out of the trade early.
As you can see, the trade would have already been stopped out with 210 pips of profit. Using the previous strategy, 216 pips has already been locked in and you are still in the trade for potentially more profits. I prefer to trail the stop on the close of the candle since price spikes and random market movement can lead to being stopped our prematurely.
Regardless of which strategy you are using you need to figure out what the pip number for your trailing stop should be. You need to take into account the time frame you are trading and the currency to figure out a good pip number to use. The goal is to find a number of pips that lets you follow price action and lock in profits, without being unnecessarily stopped out by random price movement.
Fractal Trailing Stop Method
This is another simple trailing stop strategy that uses Bill William’s Fractals to determine stop levels. Fractals appear on retracements in a trend, which make nice places to place your stop. Basically, when a new fractal appears on the chart in the direction of the trade, you move the stop loss.
This is a sell trade on the EURUSD Daily chart. As you can see, the stop loss was moved 4 times before being stopped out by price action. The first move reduced risk on the trade. The next three moves locked in profits. The trade was finally stopped out with 249 pips of profit.
With both these trailing stop strategies, the goal is to get into a risk free trade and lock in as much of the profits as possible. It is much less stressful to trade when you no longer have risk on the trade. Plus, locking in profits can keep you from closing the trade out too early while you ride trending markets for bigger gains.
In the next post I’ll go over more trailing stop strategies for you to consider. In the meantime, if you have a favorite trailing stop method, leave a comment below.