Hello Forex Traders,
For those who celebrate Thanksgiving I hope that you had a lovely day!
Today our article will focus on trail stops as a trade management method. Does a trail stop make sense?
Or is better to use a take profit and a fixed reward to risk (R:R) ratio? Those questions and more will be discussed but this is certainly an open debate in which I encourage you to share your experiences and feedback down below.
Do you use trail stops?
Have you tested the trail stop effectiveness before using it?
If you do not use it, why not and what do you think is better?
TRAIL STOP OPTIONS
There are various ways of implementing a trail stop. Here is a list:
1) An immediate trail stop on the same time frame
2) An immediate trail stop on a higher time frame
3) Trail stop after a target has been hit
4) A mix of hard take profit and trail stop
5) Increasingly tighter stop loss when in higher R:R levels
6) Discretionary (open for later decision: no take profit or trailing stop)
There are various methods which can be used for a trail stop:
1) Moving averages
2) Bollinger bands
4) Swing high, swing lows
5) Support and resistance
6) Fibonacci levels
What do you think is best? Which method would you add to the lists above?
TRAIL STOP BALANCE
The advantage of the trail stop is that a Forex trader lets some of their winners run and cuts some of their losses short. This is a very powerful concept in Forex trading, where increasing one’s average R:R win versus average R:R loss is a pivotal part of becoming profitable.
Some important notes that deserve attention.
1) Any trail stop must be tested for its effectiveness and profitability before implementation. A Forex trader must test how various trail stops work in comparison to their strategy for a decent amount of trades (at very minimum couple of hundred trades) to gain insight whether this is an improvement compared to a hard TP, and if so by how much. It is important to review the long-term data such as the profitability, drawdown maximum, average win, average loss, number of maximum losses, number of wins that win more than the maximum loss compared to total wins. This information provides details which system has the best balance.
2) Avoid over analyzing the topic. Yes this part of Forex trading deserves time and attention, but every trail stop and hard take profit will have certain disadvantages and advantages. Forex traders need to accept that one particular method will never be perfect. There will always be examples where 1 trail stop works better than the other. We must accept that to succeed.
A chosen trade management method must always be in sync with the trading psychology. Just like anything else, it is vital to have harmony between one’s own strategy, risk management, money management and psychology.
ADVANTAGES VS DISADVANTAGES
Both the trail stop and the take profit levels have certain advantages and disadvantages.
Trail stop pro’s:
a) A trail stop would allow the market to decide how far it wants or does not want to go instead of the Forex thinking for the market. The Forex trader thereby “rides the tide” and “goes with the flow”.
b) A Forex trader would be less nervous about “giving” back profits when a trail stop is used. The trailing stop helps protect the trading capital by the sheer fact that a Forex trader moves their stop loss to a level that is closer to the entry, which thereby “locks in” a smaller loss or profit. This in turn gives the psychological benefit that the trader knows their trade will not reverse from being ahead 2:1 R:R back down to a full loss. This idea could create serious problems, such as a Forex trader “clicking out” a trade earlier than planned.
c) A trail stop allows for massive wins – occasionally. These massive wins can seriously spike the equity curve to new levels.
Take profit pro’s:
a) Take profits smooth out the equity curve. Trail stops have the potential of creating smaller wins, smaller losses, and occasional bigger wins, which creates a more volatile equity curve. Take profits have a smooth equity curve compared to trail stops because the answer is always simple: either a win or loss.
b) The Reward to Risk ratio is easier to calculate with a take profit because the potential reward is a given.
c) A take profit requires less trade management time. With clear levels where a Forex trader wants to exit the market for a loss or profit, it would be easier to create a “set and forget” mentality. A trailing stop does require attention.
Last but not least, it is important to know your strategy and contemplate what approach might be better suited. An intra-day trader might not want to use a trail stop because this trader wants to close out their position before the close of the trading day and/or they could give up too much profit compared to the expected daily range. A swing trader, however, does not have this time constraint. But they too would need to create a trail stop that is executable in terms of time, because Forex traders cannot monitor the markets 24 hours all 5 days. This means either creating a trail stop which can be monitored by reviewing the charts a couple of times a day or by trading in a group of traders who check the positions on a constant basis.
Also, of course, there is the question what type of strategy one is implementing. A Fibonacci strategy will use Fib levels as a take profit level. A break out strategy, however, could be very well suitable for a trail stop. Then again, for a range strategy the take profit level could be better suited. A reversal trade might want to incorporate a trail stop after a certain profit has been reached, whereas a trending trade setup could seriously benefit from a trail stop loss as the price extends in one direction.
What do you think are the advantages and disadvantages? Do you agree with the above? Let us know down below!
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