Trailing Stop
Definition
A trailing stop is a dynamic stop-loss order that automatically moves in your favor as the trade profits — locking in gains incrementally — but stays fixed if price moves against you, converting a winning trade into a loss-protected exit that captures the bulk of a trend without requiring you to predict the exact top.
Example
“I entered at $22.00 and set a 5% trailing stop. Stock ran to $25.50 and my stop moved up to $24.23 (5% below $25.50). When it pulled back to $24.23, I got stopped out with a $2.23 gain per share instead of giving back everything trying to call the top.”
Detailed Explanation
The trailing stop solves the oldest dilemma in trading: when to take profits. If you exit at a fixed target, you often leave money on the table in a strong trending move. If you try to hold for the maximum gain, you frequently give back a significant portion before the trend reverses. A trailing stop threads the needle by defining your exit as "whenever the stock retreats X% (or X dollars, or X ATR units) from its highest point since you entered." You don't have to predict the top; you let the market tell you the move is over by pulling back through your trail level.
The trailing distance is the key variable. Too tight (1–2%) and you get stopped out on normal intraday volatility before the trend has finished. Too wide (15–20%) and you give back enormous gains before exiting. The right trailing distance depends on the typical volatility of the instrument you're trading and your time horizon. For intraday momentum trades, ATR-based trailing stops (trailing by 1.5–2x the average true range) adapt to the current volatility of the stock rather than using a fixed percentage. For swing trades, a percentage below the prior day's close or below a key moving average is common.
One key limitation: trailing stops don't handle gaps well. If your stop is trailing at $24.23 and the stock gaps down to open at $22.80 the next morning, you'll fill near $22.80 — much worse than your trail level. This is why trailing stops are better suited to intraday exits (where the trail level is actively monitored and gaps don't apply) than to overnight positions where gap risk is real. For swing positions, a hard stop below a key support level combined with manual management is often more appropriate than a pure mechanical trail.