Trailing Stop Loss Orders
Trailing stop loss orders have three uses:
- To limit your losses,
- To protect your profits, or
- To prevent you from entering (or exiting) a trade too early or on a false signal.
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The rules below are based on Screen 3 of the Triple Screen trading system, described by Alexander Elder in Trading for a Living.
When you get a signal to go long - place a buy order one tick above the High on the signal day. If price rallies, you will be stopped in on the next day. If price falls, the buy order will remain untouched. Move the buy order down to one tick above the High on the second day. Continue to lower the buy order on each subsequent day until price rallies and you are stopped in.
When you are stopped in, place a stop loss below the Low of the recent down-trend (the lowest Low since the signal day).
When you get a signal to go short - place an order to sell short one tick below the Low on the signal day. If price falls, you will be stopped in on the next day. If price rallies, the buy order will remain untouched. Move the sell-stop up to one tick below the Low on the second day. Continue to raise the sell-stop on each subsequent day until there is a correction and you are stopped in.
When your sell-stop is executed, place a stop loss above the High of the recent up-trend (the highest High since the signal day).
* Day 4 makes a new High and a new Low. If the High was made before the sell-stop is reached, the stop-loss will be placed as shown. If the sell-stop was activated before the new High was made, then the stop-loss would have been placed above the High of Day 3 and the trade would have been stropped out on making the new High.
Active or Reactive?
Many investors follow active strategies but end up being reactive, rotating in and out of stocks at the wrong time.
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- %K falls below 20. Place a trailing buy-stop just above the day's High of $33 1/2.
- Move the buy-stop down to $33, above the High of day 2.
- Move the stop down to above the High of day 3.
- Move the stop down to $32 1/2 - one tick above the High on day 4.
- The day opens with a new Low of $31 3/8 and then rises until we are stopped in at $32 1/2. Place a stop-loss below the Low (i.e.. the lowest Low since day ). Thereafter, price falls back to the day's Low, but fails to activate the stop-loss one tick below.
The rules for sell and buy stops are sometimes varied by excluding inside days:
- no adjustment is made to a buy-stop if the day does not make a new low;
- no adjustment is made to a sell-stop on days that do not make a new high.