What are the advantages/disadvantages of trailing stop loss?

General
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Placing a trailing stop loss ensures that when you take a position and when the position you’ve taken is moving in the direction that you want it to move in, you exit with a small profit/lower loss as against the loss that you would have suffered if you’d placed a normal stop loss order.

Assume your view on Reliance Industries is bullish and for that reason you buy Reliance at 1045. You place a Stop Loss order at 1040 and a target order at 1055.Let’s assume the stock moves until 1054, does NOT hit your target order and drops down to 1040. This would mean that the position that you took at 1045 now ends up making a loss despite of moving in your direction.

Now let’s assume you’d put a trailing stop loss. When the stock price moved up, just the way you wanted it to, the stop loss gets updated and when the Stock price went to 1054, your SL order would have gotten updated from 1040 to maybe 1048/1049. Now if the stock price drops back, you’re atleast making a minimum profit as against losing, as happened in the first case.

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The main advantage of Trailing SL is it lets the Winners Run. Remember "Cut your losses and let your profits run" 1st Part (Cutting losses) is taken care by SL and 2nd part (Let profit run) is taken care of by Trailing SL.

Having said that, Trailing SL also has similar pros and cons as regular SL. If it is too close, there is a possibility of early exit and then market continues for bigger moves. Keeping it too wide gives away quite a bit of profit.

Lets look at 3 Trailing SL mechanisms (following 3 are just for illustrative purposes and there could be many more and better Trailing SLs).

1) Parabolic Sar - Initially wide, it moves very fast as the position becomes favorable. This some times causes quick exits and many times market resumes the trend for a big move. Its good for short term trades when one has good re-entry strategy. But for someone who finds difficult to enter the market, may get exited early and miss the big move.

2) 20 SMA - It's move is slower than Parabolic Sar, but with slight consolidation, it may triger exit. Again ok for some one who can re-enter market. But for some one who cannot monitor market as frequently, it may cause miss out on large part of the move.

3) Super Trend - It does not move as fast and hence lets remain in the position for a longer time. In fact it does not move at all when market is consolidating. Yes when market turns around it will give away larger chunk of profit but for people who find difficulty in entering the market or for people who can not monitor day to day, this could be best option.

So each type of Trailing SL has its own advantage and dis-advantage. It is the whole Trading System - combination of Entry Techniques (along with Re-entry Techniques), Exit Strategies (Targets, SL and Trailing SLs), Risk Management and Position Sizing where one factor can make up for advantage/dis-advantage of other factor or it can enhance the other factor, that makes the difference. It is very critical to Back Test and do Walk Forward testing of the entire system to see the results before real trading on it.

Finally one should not move the SL to break even very quickly. Its very common for market to test the prior highs/lows (e.g. double bottom and tops). This could cause an early exit. One should only begin to trail SL once the position moves enough and the probability of re-test decreases.

All the above discussion was about Trailing SL as a strategy.

Attached is chart of Nifty since Feb - ParSar 5 Exits, 20 SMA 2 Exits and Super Trend is yet to trigger. Again this only for illustration purpose.

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Ajay, thank you very much for your detailed answer.

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You are welcome Saiprasad. But do remember I am just a trader like you so do verify everything

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Thank you very much Venu

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Thanks for the detailed answer, Ajay. Which software is the above chart taken from? How can I add these indicators?

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This chart is taken from Spider software. Most of the charting packages have these indicators ready made. One has to just select them and add to chart.

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Hi Ajay,
I read your guidance. Today (5 Apr 17) I had done a sample low Qty (25) transaction on BOB (BANKBARODA) at 3:08 PM.
Entry with bracket order at 174.65 (average price was 174.6). Target was 2 absolute and SL was 1 absolute with Trailing SL was 0.5 (I don’t know what it had taken. assuming absolute value and not ticks). Now as per this set order ,Price moved up to 174.85 in one minute chart. it varied between 174.7 to 174.5 for some time and then it fallen to 174.35 and my TSL triggered and executed order at 174.35… In a way it helped. as my SL value was 1 = 173.65 which recovered to 174.35. every thing is good here but what I didn’t understood is, when Trailing was 0.5 which means SL should have moved up by 0.5 when Price reaches (174.6+0.5) 175.1. This didn’t happen on chart. but SL moved up. How / when this can happen?
Look forward to your response