What is a Trailing stop loss?
Once the trade goes in your favor, it is used to lock the gains.
Before understanding the HOW of TSL, first, we should know the WHY of it.
So, WHY USE TSL?
You won’t like to see a nice amount of profit turn into a loss.
1) We should be exiting the stock at signs of a trend reversal.
2) We don’t know for how long the trend will last.
3) It helps you psychologically as a Trader, ask someone who doesn’t use a TSL, how the equity curve makes huge Fluctuations.
Now let’s move on to the HOW of the TSL-
There are many ways to use TSL, these are a few of them-
1) Swing points with ATR-
Now, as you might know, A good Trend is where the stock is making a series of higher highs and higher lows.
Example of a Good trend-
Now, These Swing points are important levels and if they get broken can affect the trend.
So, we can use them as Trailing SL levels.
But, how and what’s the use of ATR in all this?
Let’s understand –
These Swing points are easily visible to even the naked eyes.
So many times price just comes to a few points below these levels and then again moves towards the side of the bigger trend.
This is why we should Use a Volatility filter so that we don’t get whipsawed during the normal volatility.
ATR indicator is used to measure volatility.
In simple terms –
Average true range (ATR) is a volatility indicator that shows how much an asset moves, on average, during a given time frame.
Let’s see How we can apply this –
The first thing you should remember is not to Trail too early, you might be wondering why?
Let me tell you the Trends are most difficult to trade in the first 20% and last 20% of the total move. They are most volatile in these phases.
So, Even if your entry is great, you can still get into trouble if you Trail too early.
So at least wait till the trade goes at least 1R in your favor before moving your Trailing stop loss.
Now, let’s move forward as see how to use Swings pivots with the ATR –
- Big candles –
Many times you would encounter huge candles on the chart.
Now, these candles show that there are strong players behind this move.
Now, This candle will play an important role in the current trend.
As if it broke below this candle low, the highly bullish momentum will fade and it can revert to the mean very fast.
So, we can use this candle low as our Trailing SL.
Another thing that can happen is that after this bullish candle if it does not show any follow-through move in the next 5-7 candles, then it could also turn into a trend reversal.
If it breaks those 5-7 candles low.
R based trailing –
In this method, we will Trail the stop loss based on R.
Say we decide that we will trail the SL, 1R with every 1R movement.
R = Entry – SL
Say we enter a stock at 1000, our SL was 980.
Now, R = 1000-980 = 20
2R will be 40.
3R will be 60. etc.
Now we will trail SL to 1000 when the price moves 1R OR 20 points in our favor, which in this case is 1020.
Then again at 1040, we will move our TSL to 1020.
Moving average method-
In this method, we use the moving average as a Trailing Stop level.
When the price closes below the moving average we close the trade.
You can use any moving average that suits your method if you want to catch bigger trends go for 20 MA or 30 MA but if you want to catch smaller moves you can use 10 MA.
Gaps can be important for us to decide our TSL level.
Most of the time if a stock is gapping up or down significantly,
Generally, it is due to high sentiments, News, announcements, etc.
So, this gap plays an important role in deciding whether the current trend will last or not.
But if a gap is strong, either the day will be open= day low, or the day low will form in the first 30 min of the day.
So, we will use this as a TSL level, with a volatility filter of 0.5 ATR.
Many times you will see that whatever method you choose, sometimes the price just Hits your trail SL and again starts to move in your direction.
Now, to counter this, we can do one thing.
USE COMBINATION OF TSL METHODS-
Even if one method hits the TSL, and if the trend resumes again you will still be in the trade because another method did not give the exit.
This is how you can do it-
1) Swing points + Moving average –
I have explained to you how to use both the swing point and moving average method in Trailing.
So, now what you have to do is exit 50% qty when the swing point hits the TSL and then exit 50% qty when the moving average TSL hits.
This way you can diversify your exits.
Now, you can use many other combinations like –
- Trail ½ position with every 1R move in price and ½ position with 2R move.
- Exit ½ position at some fixed target and Trail ½ position using Moving average method.( Though I don’t like setting targets personally).
- Trail ½ position with every 1R move in price and place other ½ 1 ATR below the R-based TSL levels.
You got the point, Right? We are diversifying our exits using different TSL methods.
This way you will be able to catch most of the trends easily.
Thanks for reading 🙂