Trailing Stop Orders: Mastering Order Types

A trailing stop order is a variation on a standard stop order that can help stock traders who want to potentially follow the trend while managing their exit strategy. Here we explain trailing stop orders, consider why, when, and how they might be used, and discuss their potential risks. 

A trailing stop order is a conditional order that uses a trailing amount, rather than a specifically stated stop price, to determine when to submit a market order. The trailing amount, designated in either points or percentages, then follows (or "trails") a stock's price as it moves up (for sell orders) or down (for buy orders).

Upon submission, the trailing stop order remains in force until it's triggered by a specific change in the inside bid price (for sell orders) or the inside ask price (for buy orders). Once triggered, it becomes a market order and is submitted for immediate execution.

After the market order is submitted, it generally will result in an execution, but there's no guarantee that you'll get any specific execution price or price range. The resulting execution price may be above, at, or below the trailing stop's trigger price itself.

When using a percentage for the trailing amount, remember that the actual point spread between the current price and trigger price will vary as the trigger price is recalculated.

• For sell orders that use a percentage as the trailing amount, the point distance between the security's price and the trigger price will widen as prices move higher.
• For buy orders that use a percentage as the trailing amount, the point distance between the security's price and trigger price will narrow as prices move lower, since the percentage will be based upon a new, lower price.

Trailing stops can provide efficient ways to manage risk. Traders most often use them as part of an exit strategy.

For trailing stop sell orders, as the inside bid increases to new highs, the trigger price is recalculated based on the new high bid.

The initial "high" is the inside bid when the trailing stop is first activated, so a "new" high would be the highest price the stock achieves above that initial value. As the price moves above the initial bid, the trigger price is reset to the new high minus the trailing amount.

If the price stays the same or falls from the initial bid or highest subsequent high, the trailing stop maintains its current trigger price. If the declining bid price reaches, or crosses down through, the trigger price, the trailing stop triggers a market order to sell.

Trailing stop orders will only trigger during the standard market session, 9:30 a.m. to 4 p.m. ET. They won't trigger or be routed for execution during the extended-hours sessions, such as the pre-market or after-hours sessions, or when the stock is not trading (e.g., during stock halts or on weekends or market holidays).

You can decide how long your trailing stop will be effective—for the current market session only or for future market sessions as well. Trailing stop orders that have been designated as day orders will expire at the end of the current market session if they haven't been triggered. But good-'til-canceled (GTC) trailing stop orders will carry over to future standard sessions if they haven't been triggered. At Schwab, GTC orders remain active for up to 180 calendar days unless executed or canceled.

Trailing stop orders submit a market order when triggered, generally offering execution. Managing a position is essential in trading and it's important to understand the risks you face when using trailing stops.

• Stock splits. The triggering of a trailing stop order relies on market data from third parties. Your order may be set off prematurely as a result of a stock split, symbol change, price adjustment, and/or incorrect value or an away-from-the-market value sent from one of the third parties.
• Gaps. Trailing stops are vulnerable to pricing gaps, which can sometimes occur between trading sessions or during pauses in trading, such as trading halts. The execution price can be higher or lower than the trailing stop's trailing amount or trigger price; the trailing amount or trigger price only indicate at what price you want the market order to be submitted.
• Market closure. Trailing stops can only trigger during the regular market session. If the market is closed for any reason, trailing stops won't execute until the market reopens.
• Fast markets. How fast prices move can also affect the execution price. When the market fluctuates, particularly during periods of high trading volume, the price at which your order executes may not be the same as the price you saw at the time the order was routed for execution.
• Liquidity. You could receive different prices for parts of your order, especially for orders that involve large numbers of shares.
• No market for the security. If there's no market for the stock (meaning there's no bid or no ask available) or if the stock itself is not open for trading, the market order triggered by your trailing stop can't execute.

While standard stop orders can help investors attempt either to limit losses or preserve profits, trailing stop orders offer the opportunity to do both with a single setup. Familiarize yourself with the risks and explore how trailing stop orders can help support your exit strategy.