Which Should You Use: Trailing Stop Limit or Trailing Stop Loss?

 If you are unfamiliar with the markets, it can be challenging to comprehend a trailing stop loss. The two types of trailing stop losses can be tricky for novice traders who are already having trouble with a variety of order types.

When the trailing stop loss threshold is achieved, a trailing stop loss order generates a market order (close position at market price). The order will only be filled on the current limit level or better with a trailing stop limit order, which will send a limit order after the stop price is achieved. Although they provide traders more control over their deals, trailing stop limit orders can be problematic if the price drops quickly.

Before determining whether a stop limit order or a stop order is the best option for a trailing stop loss, let's first take a broad look at trailing stop losses.

How a Trailing Stop Loss Operates

Stop losses that are trailing follow the price of a security. Simply explained, a trailing stop loss has no set cost; instead, the stop loss level continuously changes to take into account the market's upward trend.

The trailing stop loss can be calculated in a variety of ways. Simply setting the stop at a specific distance from the highest high, or lowest low if you are going short, is one method. In this manner, the stop level is progressively raised as the market changes, turning it into a trailing stop.

Additionally frequently utilized as trailing stops are moving averages. You can see how we entered a trade and how the moving average stayed in line with the trend in the graphic below. The stop loss was activated after the moving average was reached, and we ended the trade.

Trailing stop loss orders are frequently referred to as profit protection stops. This is due to the fact that they will fluctuate with the security so long as the price action supports your trade. They will, however, go into effect when the trend reverses.

Additionally, this explains why trend following tactics primarily employ trailing stops. You are in for long trends if your stop loss level moves up or down with the trend, and you quit the trade as soon as the trend turns against you.

An illustration of a trailing stop loss

Let's say you pay $50 for 1,000 shares of an asset and place a trailing stop loss 50 cents below the buy price. The trailing stop will activate and an order will be placed on your behalf to sell your 1,000 shares at market value if the price continues to decline and reaches $49.50.

However, if the price of the security increases to $52, the trailing stop loss will increase to $51.50 along with the security's maximum price (50 cents below the maximum price). Now, even if the price falls to $51.50 and you hit your stop loss, your trade will still yield an approximately 3% profit.

Orders with a trailing stop loss and orders with a stop limit

After defining a trailing stop loss, let's quickly review the two order types that are available when the market reaches the stop loss threshold.

1.Stop Orders

When the market reaches the predetermined stop loss level, the stop order order type immediately sends a market order. A market order is often completed right away since it has no restrictions on the price at which it may be executed.

2. Stop Limit Orders 

A limit order will be sent out if you utilize a stop-limit order if the stop level is achieved. An order that has a limit will only be filled at that price or above.

As a result, if you are long in a position and your stop level is reached, the trade will only be closed at the limit price or higher.

On the other hand, if you are short in a trade and the stop level is hit, you can only exit the transaction at the limit price or below.

You must therefore monitor two levels for the stop limit order:

The limit order is sent out at this level, which is known as the stop level.

Limit Level: When the stop level is reached, a limit order is executed that instructs the buyer to purchase at the limit price.

To put it another way, the main distinction between a stop order and a stop limit order is that the latter does not execute a market order when your stop level is triggered. Instead, you set a limit price, and the security won't be sold until your broker can locate a buyer or seller willing to pay that price or more.

Illustration of a Trailing Stop Limit

Consider buying 1000 shares of a security for $50 and setting a stop loss 50 cents below the highest price. The limit is set at $20 less than the stop loss.

Let's say once more that the security's price reaches $52 before tumbling back to $51.50, at which point the stop loss is triggered. A limit order to sell the security will now be automatically created by your broker. The order will now specify that the security may be sold as long as the broker can locate a buyer for the security at or above $51.30 rather than requiring that it be sold at market value (20 cent limit).

Comparing trailing stop limits and trailing stop losses

Because of its increased flexibility, it may appear from the aforementioned instances that a trailing stop limit is the best option. Though limit orders provide you much more control over your trades, keep in mind that they also come with increased dangers.

A excellent illustration of this would be the possibility that part of your order would not be executed if a security is in a free fall. Consider the scenario in which the security's price kept dropping and your broker was only able to sell 700 of your shares before the price dropped to around $51.30, which is below the limit level. In this instance, your order won't be filled until the security's price reaches $51.30 once more and your broker is able to find interested purchasers.

Contrarily, market orders have a considerably higher likelihood of being filled. Naturally, there is a chance that you won't be able to locate purchasers at a fair price and suffer a loss that is more than you anticipated. However, this very rarely becomes a problem if you trade liquid marketplaces.

Which one has won?

The sequence you should use is a trick question, to put it simply. Generally speaking, limit orders should give you more control with an increased level of risk. They should be employed by people who are only prepared to sell an asset at a fair price and who are prepared to wait if the price falls below their limit before it rises again.

For traders who wish to ensure that their position closes as soon as feasible after the stop loss is triggered, trailing stop loss orders are available. People who are really risk-averse and think that the security's price won't rise again after it falls should also choose a trailing stop loss order.

In conclusion

There are benefits to both the trailing stop limit and the trailing stop loss. Their applications will change depending on the type of trade and your forecasts for that specific security. Just keep in mind that, while the order type is significant, the stop loss should be placed at a reasonable price. You can ensure that your trailing stop loss only activates when the trade is definitely going against you in this manner.