A trailing stop order is a more flexible type of stop order, which becomes a market order at a specified stop price. You would set a trailing sell-stop order after purchasing a stock to maximize profits and minimize losses. The trailing stop price or trigger price adjusts by specified dollar or percentage trailing amounts as the stock price rises, but it remains the same if the stock price falls. Once the stock price hits the trigger price, the trailing stop order becomes a market order and fills at the best available price on the exchange.
Access the stock order-entry screen on your broker's website. Some brokers require you to specify an initial stop price as well as a trailing limit, while others would use the latest market price and the specified trailing limit to calculate an initial stop price. You would specify the trailing limit in dollar amounts or percentages. The stop price is the market price — usually the bid price for buy orders and ask price for sell orders — minus the trailing limit.
Calculate the maximum amount of loss or the minimum amount of profit that you would be willing to accept. For example, if you bought your shares at $20 and the price rises to $25, you may want to sell at $23 to protect at least $3 in profits or at $19 to limit your losses to $1.
Place the trailing stop order consistent with your profit-loss criteria. Continuing with the example, if you were to set a trailing 5 percent trailing sell-stop order when the stock is trading at $20, the initial trailing stop price would be (1 minus 0.05) multiplied by $20, or $19. If the stock price rises to $22, the trigger price would adjust automatically to 0.95 multiplied by $22, or $20.90. However, if the stock price then falls to $21, the trigger price would remain at $20.90. If the price falls further, say to $20.75, the trailing stop order would become a market order and be filled at the best available price.
- Short-term traders may want to minimize losses and set stop orders immediately after purchasing stocks, while long-term investors may wait longer before taking sell decisions.
- Your broker should adjust the trigger price downward on the ex-dividend date for companies that pay regular cash dividends. The ex-dividend date is the date on which new buyers of a dividend-paying company's stock are no longer entitled to the dividend, which is why the share price drops by an amount approximately equal to the declared per-share dividend payment.
- A trailing stop-limit order is a trailing stop order with a limit offset. In volatile and fast-moving markets, stop-limit orders prevent fills at too low or too high prices. For example, if you set a trailing sell-stop order with a 10 percent trailing amount and a 50-cent limit offset when a stock is trading at $10, the order would fill only at prices between $9 and $8.50.
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