If you’re not familiar with the concept, a trailing stop-loss is an interesting tool that replaces a traditional stop-loss. Instead of setting a defined price at which to exit your position, you set a maximum distance from the current market price, above which the stop cannot exceed. So as the position moves in your favor (market price gets further from your stop) the stop will automatically move with it to match that maximum distance threshold.

For example, let’s say you enter a BTCUSD long position at $5500. Instead of setting a regular stop-loss, you decide to set a trailing stop of $100. So as your position opens the stop is set at $5400. Good news! Your long was a sick call and price is now $5650. Your stop is automatically moved up. As soon as price crossed $5500, the stop started moving too and it will now be sitting at $5550.



Seems like a simple and harmless concept, right? Not exactly. There’s actually a fair bit of hidden risk going on. Let me explain.



Fearful Traders and False Security



Ever wonder why you never hear anyone talk about trailing take-profits? If trailing stops are so great why wouldn’t you want the same dynamic flexibility on both sides of your trade?

There’s an asymmetry here and it exists because trailing stops aren’t actually about creating more dynamic setups, they are (generally) used as a security blanket by traders that are afraid to imagine a scenario where the trade immediately goes against them.



Trailing stops appeal to the “happy path”. Think about the definition at the start of this article. It’s impossible to even conceptualize a trailing stop without immediately thinking about the trade going in your favor. The stop doesn’t “trail” otherwise.



The entire idea of a trailing take-profit seems bizarre because it forces us to think about the dark path. Suddenly your trade is framed around the possibility of price reversing against you immediately.



It’s a possibility most traders aren’t willing to confront, and it’s why they’ll always prefer the conceptual security of a trailing stop. A cognitive comfort that unfortunately has no impact on reality. The market doesn’t care about what’s going on in your head.



The Nature of Levels and Reversals



Price has a habit of reverting back to the level at which you entered a position. I’m not just talking from personal experience here, but that of many veteran traders too.



It’s a common report because entries are not accidental. Good traders tend to enter their positions at deliberate levels of significance, and such levels tend to be magnets for liquidity.



It’s why whenever I hear about someone boasting about “stop moved to breakeven” soon after entering a position and getting some positive movement I make sure to check back later. I can’t tell you how many times I’ve witnessed price reverse back into that entry level (where the stop now is) only to go on a huge run afterwards in what would have been a massive winner if they had just left their stop untouched.



Which is one of the biggest problems with trailing stops. Unless you use a ridiculously wide trail distance, you’re almost always removing the possibility of having a huge winner.



Large winning positions take time to form, and during that time there will nearly always be small reversals before the next leg up. Those reversals are what catch out trailing stop traders. So while trailing stops sometimes minimize your losses, they also have a sneaky way of cutting your winners early.



Variable vs Static Risk



Risk management is extremely important to how I trade. I almost never enter a position unless I know the exact risk/reward of my setup and the statistical edge it has in this market. Taking punts is for amateurs and it’s the reason why most fail in this game.



So naturally you should place a high value on statically defined risk. If you have a target of +5% and a stop at -3.5% then you know your risk is always going to be 1.43 as long as the trade is active. If you have a target of +5% and a stop that is constantly moving around depending on where the current price is then you have no idea what your risk is in any given moment.



If you know the winrates of all your setups you also know what risk level you can tolerate at each winrate to keep you edge positive. A dynamic risk level complicates matters enormously and forces you into situations where you have to operate with a wide range of uncertainty regarding your edge.

I encourage you to track your long term performance with and without a trailing stop loss to see where the money is really going. Logging your trades accurately like this is the only way to separate biased perception from statistical reality.

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