Thursday, August 15, 2013

What is a Trailing Stop?

Many investors, like myself, are primarily buy and hold investors. However, there are some slightly more advanced techniques, that can help to protect from losses, lock in gains, and remove emotion from investing.

One of the techniques that I use is a trailing stop. To be able to understand a trailing stop, first let's understand a stop or stop-order.

A stop is simply a request to buy or sell a stock at a certain price. If you own a stock, you can set a stop price to lock in profits, or limit losses. You set a stop below the current stock value and then if the stock drops, you will sell and be protected from losses. As the stock moves, you can adjust your stops to track the stock price, to lock in higher gains.

Which brings us to a trailing stop. A trailing stop automatically tracks the closing high, setting a stop a certain percentage below the closing high. For example, let’s say you buy a stock at $40 with a 10% trailing stop. So the stop (sell) price would be at $36. Then the stock rises to $55 over time. Then the stop (sell) price would be $50. The stock falls to $50, the stop is triggered, and you sell at $50, locking in a $10 dollar gain.

You can use this to follow a stock upwards. Let's say you hold a stock and you want to maximize your gains, but aren't sure if you should sell (or when you should sell). The trailing stop will lock in your gains as the stock goes higher, but then when it moves down, will lock in those gains.

The key is to set the trailing stop percentage wide enough that a sell won't be triggered by noise, but narrow enough to lock in a reasonable gain. You can either look back at the stock's history to get an idea of the variation.

You can set up a trailing stop with an investment account. In my case, I am with BMOInvestorline, and there is no cost to set-up a trailing stop, only commission to be paid if the stop is triggered. Also, it can only be done for stocks above $5, and in lots (a lot is 100 stocks).

This post is linked in: My Wealth BuilderMy Money Counselor


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