One of the most frequently asked questions from active traders is where do I set my CFD or Forex trailing stop loss?
This can make the difference between exiting a trade too soon or holding until the end of the trend. It can dramatically affect the profitability of your trading. To determine when to get out of a trade, studying past performance can be a useful guide to determining the next exit point.
Using a CFD or Forex trailing stop loss is an excellent exit strategy. However, determining the level of the stop loss is critical to your trading success.
A share typically has a set volatility and the stop needs to be placed far enough away to avoid the market “noise”. But at the same time, close enough to exit in the event of a change in trend.
Every market you trade will require a different percentage value as the noise varies from share to share.
A tight CFD trailing stop loss will result in a trader holding a share for a shorter timeframe than using a wide trailing stop loss.
We’ve got three different percent trailing stops below, ranging from 3 percent to 7 percent. These figures are hanging from the highest low. As you can see, the trailing stop loss does not move down.
You can see in the first chart, Computershare (ASX:CPU) is the stock we are sampling this trailing stop.
The first chart highlights a 3 percent trailing stop. You can see a few touch points intraday as well as a few days where the price closes below.
Let’s take a look at a 5 percent trailing stop loss hanging from the highest low value. As you can see, the price broke through on an intraday basis as well as closed below twice.
Using a wider stop loss of 7% hanging from the highest low, Computershare (ASX:CPU) is held for the entire period. The effect of a wider stop loss is to keep you in a share for longer periods of time allowing profits to accumulate when the stock is trending.
So which is the best percent trailing stoploss? It has to be better than a traditional stop loss too.
If you are looking for a strategy that can hold a position through some reasonable pullbacks and keep you in, 7 percent for CPU is a good figure.
But keep in mind, you will need to backtest all ranges and see how it fits in with your time frame, temperament and willingness to give back your open profits.
No matter if you are trading long or have a handful of short trades open, you can run a trailing value, such as an ATR, to help you lock in profits.
You can set the stop level, set the value and as the price continues to drop you can move your stop with it.
Either the price reached will hit your profit target or your stop price will be hit. Once it hits your stop, the position will be closed.
One way to determine the appropriate stop loss for a share is to apply the stop loss to the share before you buy it. Determine what percentage has worked in the past and then apply that percentage going forward.
This can be done by trial and error. You can use your charting software and apply the stop loss to the share with different percentage levels. Pretty much exactly like we have done above on Computershare.
Once you have found the level that is appropriate for the share historically and holds you in the share for the timeframe you are trading, use this percentage value or trail amount going forward.
As a guideline:
The most popular trailing stop loss strategy is the ATR Trailing stop strategy.
ATR stands for Average True Range.
The AverageThe true range on any day is the difference between the high and the low of the day plus any opening gap that may occur.
Fortunately, every CFD or Forex trading platform has the ATR indicator built in. So you don’t have to do any manual calculations. But it is always great to know how indicators are calculated.
In basic terms, the ATR indicator tells us how much a stock, CFD, FX pair, index or commodity is moving on a daily basis. So how volatile is this instrument?
You have likely heard about ‘time and price’. It means the market you are trading is likely going through a big price movement up or down. Or a big-time movement. A time movement means it is tracking sideways for a large period of time.
Often, a large time movement (going sideways) follows a big price movement.
As a result, people use the ATR to get clear on how much the market is moving each day.
When you see a large price movement of three times the average daily range (ATR), you know this is an extreme move.
But if the market you are trading moves 1 ATR, then all is running normal, or average.
Many traders are after the best trailing stop loss. The beauty of using the ATR is that it is based on the volatility of the market you are trading.
No matter if you are trading indices, forex, share CFDs or commodities, every instrument has its own current ATR reading.
This means you will base your trailing stop loss on how active the market is moving. This is why the ATR is considered the best trailing stop loss.
Using an ATR trailing stop is one of the best ways to avoid getting stopped out prematurely.
Consider this. You are trading the EURUSD and the average daily range (ATR) is 70 pips (as of June 2017). This means it is moving on average 70 pips.
If you place your stop loss 2 ATR away, or 140 pips, you would expect things to track along normally.
But what if, during your successful trade, the ATR for the EURUSD jumps to 140 pips as it did on the 15th of December 2016.
Your stop loss is now within 1 average daily movement. Which means your chance of getting stopped out is close to 85-90%.
When you are on a winning trade and the market you are trading doubles in volatility, the best way to ride it is via the ATR trailing stop loss.
This is the exact reason why the ATR trailing stop is considered the best overall trailing stop loss strategy.
ATR trailing stop example
Let’s take a look at several examples of using the ATR on a famous Australian stock, Qantas. The reason we are choosing Qantas is that it has been in an excellent uptrend, highlighting the best possible angle for a trailing stop loss.
We’ll run through several different ATR trailing stop values so you can see the impact it has on the stop loss.
1 ATR(10) hanging from the low
1.5 ATR(10) hanging from the low
2 ATR(10) hanging from the low
2.5(10) ATR hanging from the low
3 ATR(10) hanging from the low
3.5 ATR(10) hanging from the low
There are way too many biased conditions for this test to draw any conclusions. Except to say that in hindsight, if you find a strong up trending stock, the best value ATR trailing stop is the largest one.
Every strategy looks fantastic when you use hindsight, so please understand that we are not concluding any value is better or worse.
The right value comes down to your trading time frame, your backtested strategy results and what you feel comfortable with.
The calculation of the stop loss is important to ensure you are not sold out too early. It will also allow you to hold the share to reach your profit levels.
The level of the stop loss you choose is determined by the timeframe that you wish to hold the share. The longer the timeframe, the wider the stop loss. No matter which one you use, it will help with your risk management. It should also be helpful for that actively trading who are currently using a regular stop loss.
Determining what has worked well in the past will give an indication of the appropriate level for you stop loss.