Trailing Stop
A trailing stop is a dynamic stop-loss order that moves in lockstep with a rising security price by a fixed dollar amount or percentage, locking in gains while still protecting against significant reversals.
A trailing stop differs from a conventional stop-loss order in one critical way: rather than remaining fixed at a static price, it 'trails' the security's market price upward (for a long position) as that price climbs. The stop level adjusts automatically to stay a specified distance — the trailing amount — below the security's highest observed price since the order was placed. If the price subsequently falls by the trailing amount from its peak, the order is triggered and executed as a market order.
Consider an investor who buys a stock at $40 and sets a 10-percent trailing stop. The initial stop is set at $36. If the stock rallies to $60, the trailing stop moves up to $54. Should the stock then decline from $60 to $54, the trailing stop triggers. Notably, the trailing stop never moves downward — it only ratchets higher as the price advances.
Trailing stops are particularly valued by momentum traders and investors who want to participate in extended uptrends without committing to a specific target exit price. The mechanism essentially automates a 'let profits run, cut losses short' discipline that is widely discussed in trading literature.
Trailing stops can be specified in two ways on most U.S. brokerage platforms: (1) as a fixed dollar amount (e.g., trail by $3.00 per share) or (2) as a percentage (e.g., trail by 8 percent). Each method has trade-offs. A fixed-dollar trail can become proportionally very tight on a high-priced stock, while a percentage trail scales automatically but may be wider in absolute dollar terms for expensive securities.
Brokers handle trailing stop mechanics differently. Some execute the ratcheting calculation continuously during market hours; others update the stop only at end-of-day prices. Investors should verify their broker's specific methodology. Like all stop orders, trailing stops offer no protection against overnight gaps — if a stock opens significantly below the stop price the following morning, the execution price will reflect the opening gap, not the stop level. Understanding this gap risk is essential before relying on trailing stops as the sole risk-management mechanism for a position.