by Daniels Trading|
Using a trailing stop loss is a great way to lock in profits or limit risk in an active market. In fact, professional futures traders frequently implement these strategies to optimize their capital efficiency in real time.
Trailing Stops: The Best of Both Worlds
A trailing stop loss is a dynamic order placed on the market that moves in concert with evolving price action. It features reactive functionality, meaning that the order’s exact location depends on the behavior of price itself. Therein lies the beauty of a trailing stop: It limits risk while preserving a chance of extraordinary rewards.
Trailing stops come in all shapes and sizes and are a popular way of managing open positions in the live market. A few of the most common are static (finite number of ticks), breakeven (stop loss moves to original entry), and time-based (stop location defined according to the minute, hour, or session).
Trailing stops offer the utmost flexibility; no matter what your trade management objective may be, there’s a trailing stop strategy well suited for the job. Let’s take a look at one instance when a trailing stop loss order can lead to big profits: trading breakouts.
Trading Breakouts with the Trailing Stop Loss
A breakout is a sudden directional move in asset pricing. Market breakouts occur for a multitude of reasons, both technical and fundamental. Active futures traders often target breakout-friendly products—such as commodity, equities index, or agricultural contracts—to pursue potentially large rewards.
Trailing stops are ideal for breakout trading because they incrementally reduce risk as a market moves directionally. To illustrate, assume that Oliver is scoping out a bullish break over $65.00 in May WTI crude oil. At the traditional pit open (9 a.m. ET), Oliver executes the following trailing stop strategy:
- Oliver places a buy order for one lot of May WTI at $65.01.
- He chooses to implement a static trailing stop 25 ticks from entry with a 1:3 risk versus reward ratio
- When price hits $65.01, a stop market order is automatically placed at $64.76; a profit target (sell limit) is located at $65.76.
- As price rises, the stop market order also rises. For every positive tick above $65.01, Oliver’s trailing stop moves up by one tick.
Breakout trading is a great time to use a trailing stop loss strategy. As you can see, Oliver is attempting to cash in on swift, bullish price action above $65.00. If completely wrong, the realized loss is 25 ticks; if only marginally correct, Oliver’s liability is reduced; if correct, a 3:1 payoff is realized ($750.00).
Of course, any given trade may unfold in countless ways. Because of the unpredictability of price action, many professionals choose to couple an exceedingly large profit target with a much smaller trailing stop. This strategy is commonly referred to as putting on a “runner.” Let’s say that Oliver believes May WTI has the potential to move several dollars above $65.00. Oliver may decide that a runner above $65.00 is a worthwhile strategy:
- Oliver places a buy order for one lot of May WTI at $65.01.
- He uses a static trailing stop of 50 ticks with a 1:5 risk versus reward ratio.
- Price hits $65.01. A sell stop market order is placed at $64.51, and a sell limit order is placed at $67.51.
If WTI breaks out to the bull over $65.01, Oliver begins to limit risk while preserving a chance at large rewards. Although the odds of price immediately rallying to $67.51 are slim, check out how the trailing stop loss quickly turns risk and reward to Oliver’s favor:
| Positive Move (Ticks) | Assumed Risk (Ticks) | Risk vs. Reward |
|---|---|---|
| 0 | 50 | 1 to 5 |
| 10 | 40 | 1 to 6.25 |
| 20 | 30 | 1 to 8.33 |
| 30 | 20 | 1 to 12.5 |
| 40 | 10 | 1 to 25 |
Are You Ready to Use Trailing Stops in Your Trading?
It is important to remember that many factors can influence how any individual trade develops. And, although “catching a runner” using a trailing stop loss appears attractive, it takes a strong foundation to have the mentality needed to execute such a strategy correctly.
For insights on how to build a bullet-proof trading psychology, check out Daniels Trading’s online webinar “5 Concrete Tips to Build Your Solid Trading Foundation.” In it, you’ll learn how to hone your instincts and become an unflappable, disciplined trader.
About Daniels Trading
Daniels Trading is division of StoneX Financial Inc. located in the heart of Chicago’s financial district. Established by renowned commodity trader Andy Daniels in 1995, Daniels Trading was built on a culture of trust committed to a mission of Independence, Objectivity and Reliability.
Risk Disclosure
The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.
Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.
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As an expert in financial markets and trading strategies, I can attest to the importance of employing advanced techniques to enhance profitability and manage risk effectively. The use of trailing stop loss orders, as discussed in the provided article from Daniels Trading, is indeed a powerful tool employed by professional futures traders to optimize capital efficiency in real-time.
Trailing stops, as mentioned in the article, are dynamic orders that move in concert with evolving price action, providing a reactive functionality. This means that the exact location of the trailing stop depends on the behavior of the asset's price itself. The beauty of trailing stops lies in their ability to limit risk while preserving the potential for extraordinary rewards, making them a valuable component of trade management strategies.
The article introduces various types of trailing stops, including static (finite number of ticks), breakeven (stop loss moves to the original entry), and time-based (stop location defined according to time intervals). This diversity allows traders to choose a trailing stop strategy that aligns with their specific trade management objectives.
The focus on breakout trading in the article highlights a scenario where trailing stop loss orders can lead to significant profits. Breakouts, sudden directional moves in asset pricing, are actively sought by futures traders for their potential for large rewards. Trailing stops are particularly well-suited for breakout trading as they incrementally reduce risk as the market moves directionally.
The provided examples involving a static trailing stop with a 1:3 risk-reward ratio and a runner strategy with a 1:5 risk-reward ratio demonstrate the flexibility of trailing stops. Traders can adapt these strategies based on their market expectations and risk tolerance. The article emphasizes the importance of understanding that the outcome of any trade is uncertain and encourages traders to develop a strong foundation and mentality for executing such strategies correctly.
In conclusion, the use of trailing stops is a nuanced and versatile approach to trade management in dynamic markets. Professional traders, such as those at Daniels Trading, leverage these strategies to navigate the complexities of financial markets successfully. If you're considering incorporating trailing stops into your trading arsenal, it's essential to thoroughly understand the principles discussed in the article and possibly explore educational resources, such as webinars, to build a solid trading foundation and psychology.
