Introduction to risk management strategies for cryptocurrencies: Trailing Stops

Intermediate
March 29, 2023
Read time:
5m

Risk is inevitable when trading, but there are risk management strategies that can minimize your losses. One such strategy is to use trailing stops as part of your exit strategy.


A Trailing Stop is a type of stop-loss order that is set as a maximum percentage or value that you are willing to lose. When the price moves in your favor, the stop-loss order moves alongside it. However, if the market moves against you, the stop-loss order stops moving and reduces your losses.


For example, if an asset's price goes up from $10 to $20, the trailing stop moves along with it, but as soon as the price stops going up, the stop-loss remains locked in place.


In short, it helps traders to maximize their benefits in favorable conditions and protects them from losses in case of sudden market changes.

How do they work?

Trailing stops work similarly to stop-loss orders, automatically closing the trade when it becomes unprofitable. However, they are not set at a fixed price but rather a percentage that changes alongside the market. When triggered, a trailing stop automatically becomes a market or limit order and is ready to be executed.


When using trailing stops, it's important to find a middle ground and set a limit neither too close nor too far away from the current price. Setting it too close may trigger it prematurely, resulting in losses, while setting it too far away may result in potential losses. Many traders set trailing stops at 15-20% for optimal results.


Trailing stops can be beneficial in volatile markets where prices fluctuate rapidly. They help traders minimize their losses and lock in profits while potentially benefiting from market movements.


However, it's important to note that trailing stops are not foolproof, and market conditions can sometimes cause them to be executed at less favorable prices than the trader anticipated.

What are the benefits of using Trailing Stops?

  • Flexibility – trailing stops provide traders with increased flexibility in managing their positions. They can set a stop-loss order at a certain percentage or dollar amount below the market price and adjust it as the market moves in their favor.

  • Asset protection – when an asset drops below a set price, the trade will be automatically executed to limit potential losses.

  • Their profit-oriented nature – traders can benefit from potential gains in the market while limiting their risk. Traders can keep their positions open for extended periods and potentially benefit from larger market movements.
  • Time-saving – trailing stops can be time-efficient by eliminating the constant need to monitor the market and manually adjust stop-loss orders constantly.

What are the disadvantages of Trailing Stops?

  • Potential losses with volatile assets and false triggers — trailing stops in highly volatile markets may be triggered prematurely, resulting in the trader being stopped out of their position earlier than anticipated.

  • Execution risks – in some cases, trailing stops may not be executed at the desired price due to market gaps, slippage, or other execution risks.

  • Complexities – setting up and managing trailing stops can be complex, especially for inexperienced traders who may not fully understand how to set them up effectively.


Summary

In summary, trailing stops can be a powerful tool for managing risk and improving trading performance in volatile markets. However, traders must understand their potential risks and limitations and use them with other risk management strategies.

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