TRAILING STOPS

The question of trailing stops is always a topic of controversy. Should one have trailing
stops? Where should a trailing stop be placed? There are a variety of approaches that
provide different answers. First, the trader is new to trading and has not accumulated
many trades, and putting on a trailing stop could be detrimental to improvement in performance.
This may not seem obvious. However, a trailing stop is a predetermined pip
increment that is distant from the price. If the price moves further by 10 pips, a trailing
stop set for a 10-pip trail would adjust further. The problem with this approach is that it
is delegating to the market the decision to get out of the position. The trader should be
watching the position, and putting on a trailing stop may be an incentive not to watch. Additionally,
an arbitrary trailing stop such as 10 pips may be an invitation to being stopped
out because the natural noise and vibration of the market could easily exceed that trailing stop (remember the ATR discussion). Finally, when traders are trading for relatively
small targets such as 15 to 20 pips, it’s important to get good at achieving those
targets and not focus on pushing the profits further. Keeping in a position after it reaches
one’s goals may not be as productive as simply adding another lot to the original position.
It is easier to get a 40-pip total profit from two lots than to use a trailing stop to try to get
another 40 pips.
Rather than trailing stops, a valid approach is to move a position to break even when
possible. If the target has been reached and the trader wants to stay in, moving the stop
to a breakeven point results in a free ride on the trade. A good rule of thumb would be
if you sold a currency pair, the breakeven stop loss would be 5 pips above your entry.
If you bought the currency pair, the position of the breakeven stop loss would be 5 pips
below the purchase. In multilot trading, where a trader can capture profits on some of
the lots, it makes sense to move the stops down to a breakeven location.
Finally, mental stops are very popular and very dangerous. A mental stop is one that
can easily be changed with the onset of an emotional whim. Mental stops violate the
cardinal principle that all trades should have three components: the entry order, a stop
loss order, and a profit order.
For those traders interested in avoiding stops, using options instead of stops is an
area worth pursuing once they have experience in trading.




By Abe Cofnas