A trailing stop is a modified version of the stop-loss order. It allows traders to lock in profits and limit losses with a single trade by placing a percentage limit to close the trade if the price moves in an unfavorable direction. But compared to stop-loss, trailing stop is not fixed at a specific price level. Instead, it “trails” up (for a long position) or down (for a short position) automatically when the price is going in a favorable direction. Therefore a trader can benefit from using it if the prices move steadily in a planned direction without big opposite price movements.
A trader can use a trailing stop when either longing or shorting a contract. When a trader believes a price goes up and opens a long position, he places the trailing stop below the current market price. On the contrary, when going short, the price is set above the current market price. Traders usually place a trailing stop after the trade is open rather than at the moment of opening it, since adding it to an open trade lets the trader secure their profits and maximize their gains without taking too much risk.
The callback rate is the percentage chance from the last highest or lowest price at which the order will close out. For example, in the case of a long position, a trade with a 10% trailing stop callback rate gets sold automatically by exchange if the price goes below 10% of the purchase price. But, if the price moves 10% up from the purchase price, the stop-limit also increases by 10% from the initial level. The trailing stop moves only in one direction, and once it moves in the opposite direction by a specified percentage, the trade will get closed by the trailing stop.
A trailing stop order might come in handy for a trader who already understands the principles for setting levels and successfully using a regular stop-loss (and take-profit) order. Similar to a stop-loss, setting the trailing stop levels depends on a trader’s trading strategies and risk appetite. Choosing the right activation price and callback rate also varies on the asset class and the current market state. Especially in crypto, where the price movements can be volatile, small callback rates can close a position very quickly.
As a general recommendation, the callback rate should not be too small or too large — also, the activation price should not be too narrow or too wide. This is because when the callback rate or activation price is too close to the entry price, even normal daily market movements can trigger the trailing stop. Therefore, the trade can get stopped too early because of a temporary dip or gain, resulting in a losing trade.
On the other hand, an excessively large callback rate will get triggered only from extreme volatility, exposing a trading strategy to the risk of substantial losses. Thus, while ideal and one-size-fits-all callback rates and activation prices do not exist, lower callback rates are more suitable for stable market conditions, and higher callback rates are better for more volatile periods.
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