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If you don’t want to get knocked out of the game too early, use a trailing stop-loss in your trade setup. If you want to protect your capital while riding on the waves of the bullish momentum of the stock’s price, use a trailing stop-loss. This is Risk Management 101.
Some of you already read or heard “stop-loss”. What’s the difference between a “stop-loss” and a “trailing stop-loss”? The latter has the word “trailing” while the former does not. I’m half-kidding. 🙂
A stop-loss is fixed in value. On the other hand, a trailing stop-loss adjusts or upgrades its value when the stock registers a closing price that is higher than the previous one. Well, what for is the purpose of the word “trailing” if it does not adjust or upgrade. Does it make sense?
I’ll give an example on how to compute a trailing stop-loss. I’ll use SAN MIGUEL PURE FOODS COMPANY (PF)to demonstrate my point. Let’s say you have entered a new position at 230-apiece. Your risk tolerance percentage is up to 5%. Here’s how you compute your initial trailing stop-loss.
Risk %: 5%
Current Price: P230.00
Initial TSL = 230 – (230 *0.05)
Initial TSL = 230 – 11.50
Initial TSL = 218.50
So, for as long as PF is moving above 218.50, that means it’s still manageable for you. Why manageable? It’s still moving within the risk percentage that you can handle. Did you get it? When the price goes below 218.50, you sell.
Now, let’s say from 230, PF advances to 250. How do you adjust your trailing stop-loss then? Easy. Follow the same formula.
TSL = 250 – (250 * 0.05)
TSL = 250 – 12.50
TSL = 237.50
Did you see how your trailing stop-loss upgrades from 218.50 to 237.50?
Do you now see how it allows you to ride on the bullish price action while brutally sticking with the percentage of loss that you can only handle? Do you now see how it protects your capital and keeps your profits?
Now, what if when you entered at 230-apiece and PF did not advance. Instead, it slid. How beneficial is a trailing stop-loss in this case? While there is no profit to keep, your risk is limited. You are not like the many traders who buy first and clueless when and where to exit later. Now that’s Risk Management 101.
Do you prefer a simple stop-loss or a trailing stop-loss now? Did you learn a new thing or two? Do you think this article is worth sharing? If so, share it by all means!