Using the Trailing Stop on an Active Trade
It is a little trickier to use a trailing stop because of price fluctuations and the volatility of certain stocks, especially during the first hour of the day. Of course, these fast moving stocks are the ones that will generate the most money in the shortest period of time and are usually the ones that active traders love to play.
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| Figure 1: A trailing stop loss order |
| Source: TraderZone |
The stock was in a steady uptrend as determined by strong lines in the moving averages. Keep in mind that all stocks seem to experience resistance at a price ending in ".00" and also at ".50", although not as strongly. It's as if traders are reluctant to take it to the next dollar level.
Our sample stock is Agrium Inc. (NYSE:AGU), which was purchased at $90.13 with a stop loss at $89.70 and initial trailing stop of 45 cents. When the last price reached $90.21, the stop loss was canceled as the trailing stop took over. As the last price reached $90.54, the trailing stop was tightened to 40 cents with the intent of securing a breakeven in a worst-case scenario.
As the price pushed steadily toward $92, it was time to tighten the stop. When the last price reached $91.97, the trailing stop was tightened to 25 cents from 40 cents. The price dipped to $91.48 on small profit-taking and all shares were sold at an average price of $91.70. The net profit after commissions: $942, or 1.74%.
The stock recovered from this dip and continued higher with a new re-entry point, but it is important to set your goals and targets for active trading and stick with them. Most traders would agree that this was a good play!
Making It Work
To make this work on active trades, set a trail value that will accommodate the normal price fluctuations for your particular stock and catch only the true pullback in price. This means studying a stock for a day or two before active trading it.
Next, you need to time your trade. More specifically, look at an analog clock and note the angle of the long arm when it is pointing between 1:00 and 2:00 - you want to use this as your guide. Now, when your favorite moving average is holding steady at this angle, stay with your initial trailing stop loss. As the moving average changes direction, dropping below 2:00, it's time to tighten your trailing stop spread, as shown in Figure 1.
The Trade Advantage
The advantage to this strategy is that it removes emotion from your trading. It's important to set the value when you are calm, focused and able to make a decision based on the information presented on the charts. Also, don't second-guess yourself. You will be well served to let the trailing stop work its magic.
Trader Risk
Market makers are fully aware of any stop losses that you place with your broker and can force a whipsaw in the price, bumping you out of your position and then running the price right back up again. If you like the stock, you can always buy it back.
In the case of a trailing stop, there is the possibility of setting it too tight during the early stages of the stock garnering its support. If this is the case, the result will be the same. The stop will be triggered by a temporary price pullback, and traders will fret over profit they believe they lost. This is one psychological game that traders should completely avoid.
Your best bet is to understand that highly volatile stocks are better managed with an actual stop loss as well as a limit sell order at your target price. Let your online broker earn his commissions - it is much faster than executing a market order yourself.
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