Trading Strategy: Using Trailing Stops

Trailing Stops can Limit Risk and Lock In Profits

Trailing stops are a great trading strategy that uses stop loss orders. Simply put, as the price of the stock goes up, your trailing stop will also go up. The trailing stop prices are set at a certain percentage (%) below the current price.

As the price of the stock goes up, the trailing stop will also go up. The stop follows, or trails, the stock price, giving us the name “trailing stops”.

Only Raise Your Trailing Stop – Never Lower It!

The advantage of using trailing stops is that you only raise your trailing stop price. You never lower your trailing stop!

Why do you only raise trailing stops? You want to only raise your trailing stops to reduce risk and lock in profits.

Examples of Using Trailing Stops

Here are examples of trailing stops in action.

You buy XYZ stock at 10.00. In this example we will set our trailing stop price at 10% below the current price. Our initial trailing stop will be 9.00. How did I get 9.00? Take 10% of 10.00 to get 1.00. We’ll set the initial trailing stop at 1.00 less than the current price of 10.00. Subtract 1.00 from 10.00 to get 9.00. If the stock price hits 9.00, our trailing stop will sell our position.

Scenario: Stock Moderately Decreases in Price – XYZ stock declines in price! If XYZ declines in price to 9.50, you will not alter your trailing stop – do not lower your trailing stop order price!

Scenario: Stock Sharply Decreases in Price – XYZ is falling fast! First it hit 9.50, then kept dropping and now it is approaching 9.00. When the price of XYZ hits 9.00, our trailing stop will automatically sell the stock. We will have lost 10% of this trade’s value. Keep in mind that this is 10% of only this trade, not 10% of our total portfolio value. We knew we were risking 10% of our money in this trade. This risk is money we were willing to lose. If XYZ keeps falling to 8.00, we’ll be protected thanks to our trailing stop – we will have sold this position (at a loss) at 9.00. Our risk was limited to 10%. If we didn’t have a trailing stop in place, we would currently be down 20% on this trade – 10.00 price falling to 8.00 is 20% decline.

Scenario: Stock Moderately Increases in Price – XYZ stock increases in price! If XYZ stock prices goes up to 11.00, we will alter our trailing stop. The new trailing stop price will be 10% below 11.00. First calculate this price by taking 11.00 * 10% (10% is the same as multiplying by .10). So we have: 11.00 * .10 = 1.10. Second we will calculate the current price of 11.00 minus 1.10. We’ll set our trailing stop price at 11.00 – 1.10 = 9.90. If XYZ stock hits 11.00, our trailing stop will be 9.90.

Scenario: Stock Sharply Increases in Price – XYZ shoots up to 15.00 per share. We’ll have to calculate a new trailing stop price, again 10% lower than the current price. First calculation: 15.00 * 10% (or .10) = 1.50. Second calculation: 15.00 – 1.50 = 13.50. Our new trailing stop price is 13.50. The return rate from 10.00 to 13.50 is 35%! We’ve just locked in 35% in gains. If XYZ hits 13.50, our trailing stop loss order will automatically sell XYZ at 13.50. If XYZ falls to 9.00 per share, we won’t care. We’ve locked in profits and our trailing stop sold our positions for us.

Trailing Stops Reduce Risk

Trailing stops reduce risk by setting an absolute minimum price and monetary value you are willing to risk and possibly lose. For simplicity I will use a trailing stop price of 10% below the current stock price. The trailing stop price you use depends on your trading style, strategy, and amount of risk you are willing to accept. Some people may want to set a trailing stop at 5% below the current price, while others use upwards of 20% below the current price.

Keep in mind that some stocks are volatile and may fluctuate 5% to 10% in price per week. If your trailing stop is set at 5% below the current price, and the stock falls 5% shortly after you buy it, your trailing stop will execute and sell your stock position at a 5% loss. However, if your trailng stop is set at 10% below the current price, the stock price can initially fall 5%, then the stock price may shoot back up. Volatile stocks require careful research and analysis before you determine the trailing stop percentage to use.

Trailing Stops Lock In Profits

Trailing stops lock in profits or reduce losses when the price of the stock goes up. As the stock prices increases, your trailing stop price also increases.

If the stock continues increasing in price – say 20% above the price you purchased at – your trailing stop will lock in 10% in profits. If the stock continues climbing and hits 40% above the price you bought it, your trailing stock will also climb, locking in a 30% gain! When the stock finally declines in price, your trailing stop will sell your position, locking in a gain of 30% profits for you.

Use Trailing Stops!

Everyone should use trailing stops. They benefit you in two ways: reducing risk and locking in profits. Trailing stops are a very important and useful tool available to traders and investors, but many traders do not use them. If you plan on being a successful trader or investor, trailing stops are an easy way to increase your profits and your chances of success.

Introduction to Risk and Risk Management

Risk

Risk is the amount of money you are willing to, and could possibly, lose if your trade or investment is not successful.

Risk Management

Risk management is the planning and strategy developed to reduce your risk – or the amount of money you might lose – in the stock market.

Some people say you should only risk 1-2% of your entire portfolio per trade. This means you are only willing to lose 1-2% of your entire portfolio.

Example of Risk Management

Your entire portfolio value is $10,000. The stock you want costs $2 per share, and you want to buy 1000 shares. Total cost to purchase the 1000 shares is $2000 (not including commissions).

Risking 1% of your entire portfolio value: You will risk 1% of your entire portfolio, or $100 dollars. The share price you should set a stop loss at, with 1% risk, is 1.90 per share.

Risking 2% of your entire portfolio value: You will risk 2% of your entire portfolio, or $200 dollars. The share price you should set a stop loss at, with 2% risk, is 1.80 per share.

Added to My Portfolio: Growth, Value and Oil

My Portfolio Grows

My portfolio page was a bit out of date. I’ve added some new gems to my portfolio of stocks and investments.

I wanted to buy something long term (1+ years) and exchange traded funds (ETF) were the perfect fit for me. All three ETFs I bought are PowerShares exchange traded funds. My three ETFs cover different goals: Growth, Value and Oil

Growth

For growth I purchased PWB. PWB is the PowerShares Large Cap Growth ETF. My goal with PWB is to capitalize on the gains of future stock trading. PWB ETF invests in companies that are poised for growth. Growth is one element my investing strategy.

Value

Value is very important to me and is my most useful investment strategy. PWV is my value choice. PWV is the PowerShares Large Cap Value ETF. Large cap value finds stocks that are at a comparitively lower valuation than other stocks in their sector. The thinking is that buying stocks at a low valuation will hopefully blossom in to a very fruitful tree in the future.

Oil

I am betting on oil prices going up in the US to the $4+ per gallon range. In order to take advantage of higher oil prices and gas prices, I bought PXJ. PXJ is the PowerShares Oil & Gas Services ETF. As oil and gas prices rice, so too will the price of PXJ.

Investing Strategy: Creating a Stock Market Investing Plan – Introduction

Introduction: Creating a Stock Market Investing Plan

We all need a plan for investing our money. Ask yourself: Do you want to work for money? Or, do you want money to work for you? I know I want my money to work for me. If we’re going to be successful at trading and investing, we need to come up with a plan.

Our investing plan likely includes many different types of investments and strategies for maximizing our gains and profits. This article is an introduction to building our investing plan and will be followed by more in-depth discussion on creating a solid plan.

What can we invest in?

We can invest our money many different ways. Here are some of the more popular investments:

  • Stocks
  • Bonds
  • Real Estate
  • Mutual Funds
  • IRA
  • Trust Funds
  • Money Market accounts

Investing Strategies

Just as we have numerous avenues of investing, we also have many different strategies of utilizing these avenues to increase our investing potential.

The more popular investing strategies are:

  • Growth Investing
  • Value Investing
  • International Investing
  • Real Assets (real estate, gold, silver, other precious metals, diamonds, etc)

Find the Right Balance

A good investing strategy uses combinations of investing avenues and investing strategies.

We want to formulate an investing strategy which includes long term investments that are likely to grow over time (growth investments), and also stocks or mutual funds that are very good value investments – where we are buying in a good price.

Our strategy should also include investments which pay us money on a regular basis, such as dividend paying stocks, mutual funds, ETFs, bonds, and even real estate. With real estate, you may own an apartment building where tenants pay on a monthly basis. We can use these payments and dividends from our investments to pay our bills or to reinvest and grow our total investments even more.

Thinking Long Term

When you make investments you must be prepared to hold on your investment for a long time. The greatest rewards from investing come as you hold on to your investments over a long time period. Your investment may initially go down and you will be tempted to sell it. Many successful investors would hold on to this knowing that the market always goes up in the long run. It may go down for a year or even two years, but history shows the market steadily rises. And as the market rises, so too do investors’ portfolios.