Most traders rely on stop loss orders. They’re simple to understand and set up. But did you know that a trailing stop can often be more effective than a stop loss order?
Market orders were a mystery to me when I first entered the crypto market. I have only invested at the time, so market and limit orders were everything I knew about market orders. But as I bravely started to experiment with trading cryptocurrencies, I found out that there are more than two types of orders.
Most market participants know the basics: limit, market, stop loss, and take profit orders. They require fixed price points and you know that your exchange will activate these orders as soon as the price hits your order. In this article, I’m going to introduce you to a more advanced type of order: a trailing stop order.
What Is a Trailing Stop Order?
A trailing stop order is a modified version of the stop loss order that enables you to prevent losses and secure profits in a trending market. A regular stop loss order closes your position at a fixed price point. However, a trailing stop order closes your position at a fixed percentage point. I’ll use a real life example to show you how the two are different.
Let’s say I open a long position on Bitcoin at $20,000. I’m ready to lose 10% of my capital, meaning that I will create a stop loss order at $18,000. My long position turns out to be a success as Bitcoin moves towards $25,000. However, I fail to take profits and the price falls down. Soon enough Bitcoin reaches my breakeven point ($20,000) and after a few hours it triggers my stop loss order after hitting $18,000.
What happened here is that I’ve missed an opportunity and suffered losses. I refused to take profits at $25,000 believing that the price would go higher. Moreover, the price retraced back to my entry, only to hit my stop loss. This set of events led to a 10% loss.
Now let’s analyze how the situation would play out with a trailing stop order. I open the same position at the same price. The only difference is that I place a trailing stop order of 10%. Bitcoin moves to $25,000 only to fall down. But wait, the exchange triggers my trailing stop order as Bitcoin drops 10% from $25,000 and hits $22,500. I close the position and end up with a profit of 12.5%.
Advantages of a Trailing Stop Order
In the previous example, I have shown you the power of a trailing stop order. Instead of focusing on a price point, you order the exchange to close your position exclusively in the case that the price drops a certain amount. The defining advantage here is that you secure profits and prevent the price from retracing to your entry. And if the asset doesn’t pump at all, you’ll still limit your losses to 10%.
Trailing stop orders come in handy in a trending market when traders are often afraid of two scenarios:
Not taking profit on time
Taking profit too soon
You risk missing out on profits or losing money by not taking profit on time. An asset may jump very quickly in value only to erase all its gains within hours. You’re making a mistake by being too bullish and having high expectations.
You’re also making a mistake by taking profits too soon. You might proudly close a position after securing a 40% profit only to find out that the price continues pumping. Don’t get me wrong, you should still have a smile on your face for being profitable at all – most traders don’t get the chance to be in your position. However, you need to understand that you’re required to maximize your profitability whenever possible.
In the first case, a trailing stop order helps you automatically secure profits in the case that the market decides to fall back down. In the second case, the order prevents you from taking profits too soon in an uptrending market. And in both cases, the order moves along with the market until the moment it doesn’t.
To summarize: trailing stop orders limit losses while also locking in profits.
Disadvantages of a Trailing Stop Order
Don’t let this article fool you – trailing stop orders aren’t perfect. They’re ideal in certain situations – like trending markets – but they can also have devastating effects under other market conditions.
Trailing stop orders are problematic in volatile markets. You don’t have much use for this order when an asset can move 10-30% within hours. And you can still face problems even if the price doesn’t instantly trigger your stops. For example, an asset’s price can move up, drop 10% and trigger your stop, and then resume moving up.
The only way to counteract volatile market conditions when using trailing stop orders is to open a position at the lows. Your entry point shouldn’t be located neither at the highs nor at the middle of a price channel. Attempt to hit the lowest entry point possible. But if that isn’t possible, I recommend not using a trailing stop order at all.
Portfolio Trailing Stop Orders on Shrimpy
Not everyone trades. Trading cryptocurrencies can be highly difficult due to their volatility. Moreover, most people prefer to invest rather than trade. But do investors have access to a feature similar to trailing stop orders?
On Shrimpy, an automated portfolio management platform, you can activate a portfolio stop loss. A portfolio stop loss functions the same as a trailing stop loss order. The only difference is that the former affects your entire portfolio, and not individual assets or trade positions.
Let’s say you have invested $10,000 into four cryptocurrencies. You bet that the market will go up, but still wish to protect your capital in case things go wrong. What you want to do in this situation is to activate a portfolio stop loss that triggers once your portfolio suffers a 10% loss. So if the market drops and the dollar value of your crypto portfolio drops by 10%, Shrimpy will sell your assets and convert them into a stablecoin of your choice
Portfolio stop loss orders achieve the same goal as trailing stop orders: they secure profits and prevent losses. The way this works is by setting up a portfolio stop loss in the automation tab. You can set a threshold percentage and decide on which time basis the threshold activates. For example, you can sell your assets into stablecoins if the portfolio crashes by 5% within a single day.
Whether you’re a trader or an investor, your goal is still the same: capital protection. While traders have access to trailing stop loss orders on nearly every exchange, investors rarely have such a feature to protect their portfolio. But with the help of Shrimpy and its portfolio stop loss orders, you too can protect your capital.
If you want to learn more about protecting your investments, I recommend reading the following articles:
Marko is a crypto enthusiast who has been involved in the blockchain industry since 2018. When not charting, tweeting on CT, or researching Solana NFTs, he likes to read about psychology, InfoSec, and geopolitics.