In the highly volatile world of forex trading, it is not uncommon for a steadily increasing currency pair to tumble instantaneously. Often, investors end up paying most of their gains by holding onto their currency pair hoping that the downturn is temporary. Trailing stops are an excellent exit strategy to minimize risk, limit losses and avoid such a scenario altogether.
An important advantage of setting a trailing stop over other forex exit strategies, such as a standard stop loss, is that the stop loss level in case of a trailing stop rises proportionally with rising currency prices. However, if the prices tumble, the stop loss rate remains the same. This enables traders to limit losses and maximize profits without placing new stop loss orders repeatedly.
Setting Forex Trailing Stops
A trailing stop loss order can be set in three different ways. The most common methods are to set a trailing stop at a set percentage or at a set number of points below the present trading price. Additionally, a trader can set a trailing stop as a definite stop price on the basis of support level or a technical indicator.
Trailing Stop Percent
In this strategy, the trailing stop level moves by a set percentage in the trend’s direction. This implies that the trigger price (buy/sell order) readjusts every time a fresh high is attained. However, if the price moves in the reverse’s direction, the trailing stop remains at the previous level.
For instance, an investor sets a 10% trailing stop on EUR/USD when the pair is trading at 1.4010. At this price, the trailing stop will be at 1.2609 (i.e., 1.4010 - 0.1401). On reaching this price, the investor will execute the trade. If, however, the pair’s market price increases to 1.6010, the trailing stop level will increase to 1.4409 (1.6010 – 0.1601).
Trailing Stop Price
Similar to the trailing percent method, this strategy entails setting a trailing stop at a set number of points under the high price, rather than as a percentage. The only difference between the two methods is that the trailing stop price is more precise. This is because it helps to arrive at an absolute stop; unlike in the case of the trailing stop percent method, which tends to have slight variances in the stop level due to percentage-based calculations.
Finally, setting a trailing stop on the basis of a support level entails taking advantage of the market psychology embedded in the price of a currency pair. The support level is that price beyond which a currency pair will cease to decline. At this level, there are more buyers than sellers. This method of setting trailing stops is less popular as it does not reset the stop price automatically. Instead, traders have to review technical indicators and other resources like moving averages to identify new support levels and adjust the forex trailing stop accordingly.