Thanks to the technique of ‘trailing your stop loss’ you can prevent yourself from being in this situation. In fact, at times trailing stop loss gives you a chance of making a better profit than you originally thought about.
The concept of trailing stop loss plays a crucial role while trading. Consider this situation (in fact most of us would have been in this situation) – you buy a stock at Rs 250, with an expectation that the stock price will hit Rs 270 sooner or later.
You keep a stop loss at Rs 240 (just in case the trade goes against you) and hope for the best.
Things move as expected, the stock rallies all the way from Rs 250 to Rs 265 (just a few rupees away from your target of Rs 270); however, thanks to market volatility it starts to retrace back…all the way to hit your stop loss at Rs 240.
So, in essence, you saw profits coming in for a brief while but were eventually forced to book a loss. How do you deal with such a situation?
More often than not we are always put in such a spot, where we are right about the overall direction but get ‘stopped out’ due to market volatility.
Well, thanks to the technique of ‘trailing your stop loss’ you can prevent yourself from being in this situation. In fact, at times trailing stop loss gives you a chance of making a better profit than you originally thought about.
Trailing stop loss is a simple concept. All one needs to do is adjust the stop loss based on the movement of the stock. Let me illustrate this with an example. Here is a typical trade setup -
Clearly, the idea is to go long at Rs 2175 and keep a stop loss at Rs 2150. The idea is to adjust the stop loss as and when the price moves in the direction of the trade.
To be precise, for every 15 points of price movements in the direction of the trade the SL can be adjusted accordingly. The SL can be adjusted to any level with an idea of locking in the profits.
When you adjust the SL with an intention to lock the profits, it is called “Trailing Stop Loss”. Do note, in this example, I have randomly opted for a 15 point move, but in reality, it can be any kind of price move.
Have a look at the following table, as and when the price moves 15 points in the trades favor, I trail my SL and thereby lock in a certain amount of profit.
Do note, the original price target was Rs 2,220, but thanks to the trailing stop loss technique, I can ride the momentum and close the trade at a higher price point, i.e. Rs 2,230.(Disclaimer: The author is VP, Educational Services, Zerodha. The views and investment tips expressed by investment experts on Moneycontrol are their own and not that of the website or its management. Moneycontrol advises users to check with certified experts before taking any investment decisions.)