Understanding how to use a trailing stop loss to realize a maximum profit on stock sales while minimizing losses can be a good investing strategy. Not only does this practice trigger transactions based on market movements, using a trailing stop loss can help take the emotion out of the decision making process.
Here are a few examples of using trailing stop loss:
You purchase stock at $50.00 and a trailing stop loss order of 20% (or $40.00). One year later this price has risen to a new high of $55.00, this means your trailing stop amount would be $44.00 (or 20% of the highest price). If this stock continues to perform as it has, you will see a steady rise in your profit levels. If the price rises to $80.00, your trailing stop loss limit would also rise to lock in the profit at $64.00. You will be able to protect the profit you’re earning. The price would have to drop back down to $64.00 before the stop loss triggers a sale.
After market close, set your trailing stop loss order beneath the lowest price between the current days’ low and the previous days’ low. If the previous days’ low was $9.00, and the current days’ low is $10.00, you will set your trailing stop loss at $9.00. On the next day the low is $11.00. You will then re-set your trailing stop loss order to the new two day low of $10.00. If this stock performs in this manner for the next few days, you will constantly move your trailing stop loss order higher, reaching higher profit levels. If at any point the stock price falls below your threshold, the stock will be sold. This approach also works comparing week to week or month to month. The more volatile your stock the shorter the period of time you would use.
You know this stock is relatively stable and rises slowly, but steadily. By placing a larger trailing stop percentage (say 25%) you can, according to common investing advice, “let the winner ride”. This also helps avoid triggering a sudden sale due to a short term fluctuation in the stock price. A sale will only occur if the stock takes a turn in the other direction and your losses will still be in the range you set.