A trailing stop is a stop-loss order that moves with price. Set 5% below a long position, it rises as price rises and stays put when price falls. If price retraces 5% from its high, the stop triggers.
It locks in gains without requiring you to choose an exit in advance.
How it works
Enter long at $100 with a 5% trail. The stop sits at $95. Price rises to $120; the stop rises to $114. Price falls to $116; the stop stays at $114. Price falls to $114; you’re out, with a $14 gain instead of the $20 you’d have had at the top.
You never sell at the peak. You sell after a defined retracement from it.
The distance is a volatility assumption
This is where most people get it wrong. A 5% trail on an asset that moves 8% on a normal day gets stopped out by noise. A 5% trail on one that moves 1% gives back far more than necessary before triggering.
The trailing distance should be a multiple of the asset’s current volatility, not a round number. And volatility changes, which means a trail set correctly on Monday can be wrong by Thursday.
Where trailing stops fail
Gaps. A stop is a trigger, not a guarantee. If price jumps through the level, the order fills wherever the market is, which in a thin book can be well below the stop.
Whipsaws. In a choppy market a trailing stop can exit a position that recovers minutes later. The stop did its job; the job was the wrong one for that regime.