Today I want to continue with our discussion of trailing stop strategies. Remember, trailing stops are ways to reduce and eliminate risk once the trade goes in your favor. Instead of giving profits back to the market, you can lock in profits as you look for bigger gains. In this installment, I want to go over the Moving Average and Parabolic SAR trailing stop strategies.
Moving Average Trailing Stop
The moving average is a popular indicator used to show the average value of price over a given time period. Moving averages are generally used to determine trend direction and momentum. For example, if price is above a 50 Moving average you can consider the market in an up trend. If price is below the 50 moving average, you can consider the market in a down trend. Moving averages can also be used as a trailing stop, which is what we are going to take a look at.
There are two ways to use moving averages to exit a trade. The first is by using the moving average location to trail your stop. The second is to use a cross and close of a candle on the other side of the moving average as a signal to exit the trade.
Using Moving Averages As A Trailing Stop
In this scenario, you use the moving average position to determine where to trail your stop. As the trade progresses and the moving average position changes, you trail the stop at each candle close. In this way, the stop loss follows price and the trade is exited when price reverses enough to take out the stop loss.
Here is an example using a Simple Moving Average set to 13.
As you can see in the picture, the orange line is the moving average. In this sell trade, as the trade progresses, you would move the stop according to where the moving average is at the close of the candle. The higher the moving average value, the more room you give price action. The lower the moving average value, the closer to price action you will be trailing your stop.
Using Moving Averages To Close A Trade
This is a variation of using the moving average to exit the trade. Instead of following price using the moving average after each candle close, you only exit the trade after a candle breaks the moving average line and closes on the opposite side. This can potentially keep you from being stopped out early by random price action which can happen if you are trailing price too closely.
Here is an example using the Simple Moving Average settings of Period 3 and Shift 3. I like this 3/3 moving average for this strategy because it keeps you close to price action, but allows for nice profits since you need a break and close of the candle to exit the trade.
As you can see in the photo, price pierced the 3/3 moving average several times in the beginning of the trade. But you would not have exited the trade because price did not cross and CLOSE on the other side of the moving average. At the bottom, when price crosses and closes on the other side of the moving average, you would close the trade.
Parabolic SAR Trailing Stop
The Parabolic SAR (Stop and Reverse) is an indicator that can help find potential reversal points in the market. When price is tending up, the SAR dot is placed below price. When price is trending down, the SAR dot is placed above price. At the close of a candle, the SAR vaule is calculated for the next candle. This makes using the SAR dots good for a trailing stop.
Here is an example using the defaut settings of Step 0.02 and Maximum 0.2.
As you can see in the photo, there is a buy order. Each time a new Parabolic SAR dot appears below price, the stop loss was moved. This resulted in 15 moves of the stop loss before finally being stopped out with 300 pips profit.
Another way to use the Parabolic SAR indicator to exit trades is to simply exit the trade when you get an opposite Parabolic SAR dot. So, in the example above, you would exit the trade when the dot switched from being below price to being above price.
In the next post, I want to go over another couple of trailing stop strategies. If you have any trailing stop methods that I have not gone over that you want me to comment on, leave a comment below.
vince says
Hi,
please, could talk about linear and non linear trailing stops, a trailing stop should have volatility in consideration to adjust stop loss quicker tighter and if candles speed up
Best,
Vince.
Geoff says
How difficult is it to program for these types of trailing stops and are any available either through OSR or other suppliers. they seem so logical that they should be freely available.
Shaun Overton says
It’s very straight forward. The programming is not difficult at all.