How it works
The trader specifies a trailing distance, either in absolute price (e.g., $0.50) or as a percentage (e.g., 2 percent). For a long position, the stop sits below the highest price reached since the order was placed. As price climbs, the stop ratchets up. As price falls, the stop stays where it last was. If price falls by the trailing distance from the high, the order converts to a market or limit order and exits. For shorts, the logic mirrors above the lowest price.
Example
A trader buys XYZ at $100 and sets a 5 percent trailing stop. Stop starts at $95. XYZ rises to $110: stop ratchets up to $104.50 (5 percent below). XYZ rises to $120: stop ratchets to $114. XYZ then falls to $114, triggering exit. The position captured $14 of the $20 high-water move. Without the trailing stop, a hard $95 stop would have stayed at $95 and either exited at the original level (giving back the entire gain) or required manual management to lock in profit.
Why it matters
Trailing stops automate the discipline of letting winners run while locking in profit. The trade-off: too tight a trailing distance triggers on normal pullbacks; too wide gives back too much in reversal. Match the trailing distance to the asset’s typical pullback range, often 1.5 to 2 times the ATR (average true range). Most platforms offer trailing stops as standard; if yours does not, replicate the logic with periodic manual stop adjustments or with a bracket order.
