A trailing stop-loss is a type of order in stock trading. The use of this order will trigger a sale of the investment when the price drops below the tolerance level. A trailed stop-loss order can facilitate a stock sale decision because it is more rational than emotional. This order is designed for investors who want to minimize risk, i.e. minimize losses while maximizing profit potential. Everything happens automatically with a stop-loss command. Therefore, you and your traders do not have to keep an eye on stock prices constantly.
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Part 1 of 2: Understanding the Stop-Loss Command
Step 1. Understand how trailed stop-loss orders work
A trailed stop-loss is a type of sell order that is adjusted to the movement of the stock price automatically. Most importantly, stop-loss orders move with the increase in the value of the stock. As an example:
- You buy shares at a price of Rp. 25,000.
- The share price rose to Rp. 27,000.
- You place a stop-loss order with a trailing value of $1000.
- When the share price rises, the trailing price (stop price) will remain at the current share price minus Rp1,000.
- If the stock price goes up to IDR 29,000 and then it goes down. The trailing stop-loss order stands at IDR 28,000.
- If the share price has reached IDR 28,000, the stop-loss order will become a market order. That is, you will sell the shares. At this point, your profits are locked (assuming a buyer is found).
Step 2. Identify traditional stop-losses
Traditional stop-losses are designed to limit losses automatically. These orders do not follow or adjust to changes in the share price, in contrast to trailed stop-loss orders.
- Traditional stop-loss orders are placed at a specific stock price point and do not change at all. As an example:
- You buy shares for Rp. 30,000.
- Traditional stop-loss orders are set at IDR 28,000. Thus, the shares will be sold at a price of Rp. 28,000.
- If the share price rises to Rp. 35,000 and then suddenly falls, the shares will be sold at Rp. 28,000. You will not protect the profits that resulted from previous stock increases.
Step 3. Understand how trailed stop-loss orders help maximize your profits
Use trailed stop-loss orders instead of selling at a specific stock price point. Orders will be adjusted automatically when the stock price increases.
- Let's say you use a traditional stop-loss order and own stock for $15,000. You specify a point of sale (for example, $1,000) that won't change. If the share price rises to Rp. 20,000, you still set a sell order for the shares at a price of Rp. 10,000.
- Now, let's say you use a trailed stop-loss order and own stock for $15,000. you specify a trailing stop-loss order at the 10% level instead of a traditional stop-loss order, say at a price of $13,500. If the stock price goes up to IDR 20,000, you will still use the 10% level. Thus, the effective stop-loss order is at a price of Rp. 18,000 ((100%-10%)*Rp. 20,000). If you use a traditional order, the stock will be sold at $13,500, and you will lose the profit from the increase in the share price.
Step 4. Use an easy and proactive strategy
Thanks to the trailing stop-loss order, traders don't need to manually change the stop condition because the order will change automatically depending on the current stock price. Creating a trailing stop-loss order is very easy to do.
Part 2 of 2: Making a Tailed Stop-Loss Order
Step 1. Determine if a trailing stop-loss command can be used
Not all brokers will allow you to use this strategy. Also, not all account types allow trailed stop-loss orders. Check if your broker allows this type of transaction.
It is highly recommended to have the option of using this command
Step 2. Track the historical movement of your stock
It is helpful to understand the historical volatility and price movements of your stock. Thus, you can have an idea of the amount of increase or decrease in stock prices in a period. Use this data to determine a fair tailings value and strike a balance between selling the stock at a premature price and losing too much profit as a result of the stock price falling.
Step 3. Choose a time to place the order
You can place a stop-loss order at any time. You can do this immediately after the initial purchase. You can also track stocks and decide to set a trailing stop-loss order later.
Step 4. Choose a fixed or relative amount
As per the previous statement, trailed stop-loss orders can be created in two ways. You can use a fixed price or a relative price based on a percentage.
- For example, you can set a fixed price (e.g. IDR 10,000) for tailing or with a percentage of the share value (e.g. 10%). In both cases, the term “tailing” refers to the value of the stock. This tailing changes over time along with changes in stock prices.
- By using a fixed price option, you set a limit on the allowable fall of the share price from its highest point before the sell order is automatically set. The amount of rupiah allowed cannot have more than two decimal places.
- With the percentage approach, you can determine the appropriate range to let the value of the stock rise and fall in a general upward trend in price. The percentage used is only limited to the range of 1%-30% of the current stock price.
- Know the risks. The risk with all stop-loss orders is that the stock price may drop to the stop limit and trigger a sell-off. The stock price may then rise again causing you to lose the new accrued profit.
Step 5. Determine a fair tailings value
Determine how much your trailing stop-loss is worth. Consult a broker to set an appropriate dollar amount or percentage for your trailing stop-loss order.
- If the set value is too narrow, you run the risk of selling the stock prematurely.
- If the value of the stock is set too wide, you run the risk of allowing too much profit to be lost should the stock price fall.
Step 6. Decide whether you want a day order or Good Till Canceled or GTC
A trailed stop-loss order can be designated as a day order or GTC. This determines how long the trailed stop-loss command will be active.
- One-day orders are active until the market close of the same day (4pm). If you use a one day order when the market closes, the order will remain active until the market close the next day.
- GTC orders will be active normally for 120 days. Therefore, the order will be deactivated after 120 days have elapsed. There are some commands that allow GTC commands to be active indefinitely
Step 7. Choose between market orders and limited orders
A market order is an order to buy or sell an investment at the best available price. Restricted orders allow you to set the purchase or sale of shares at a specific price.
Once you reach the specified stop price, you can place it via market or limited orders. This means that you will sell the shares
Step 8. Market orders are default orders
This order will be executed regardless of the stock price.
