Stop-loss brokerage orders help investors limit their losses. A different type of stop-loss investment order, called a trailing stop order, may help stock buyers protect their profits on a particular stock. A trailing stop is a sell order. An investor can put in an order to sell that stock once it reaches a specific price below the current market price.
For example, an investor purchases a stock at $50.00 US Dollars (USD). The stock price then goes up, and is now at $60.00 USD. The buyer wants to protect some of his gains. The investor sends his stockbroker a trailing stop order for $2.00 USD below the current market price. In other words, the sell order price is trailing the market price.
The sell order is put on hold until the price threshold is reached. If the price continues to rise, the trailing stop price will go up along with it. The trailing stop can help ensure that the stock will be sold for no less than $2.00 USD below the current market price.
Note that the trailing stop price will not go below the original trailing stop amount. If the stock goes down immediately after the trailing stop order is placed, the sell order will be executed at the original trailing stop amount of $58.00 USD. This way the stock owner is still protected if the price goes down instead of up.
The investor can use either a dollar amount, or a percentage of the market price, to create the trailing stop order. The stock owner protects his gains with a trailing stop order by limiting his maximum possible loss. At the same time, the investor has not set a limit on his maximum possible gain.
As with all stock market transactions, trailing stops are not without risk. The stockbroker who receives a brokerage trailing stop order is required to submit the sell order for that stock immediately when the price threshold is reached. Still, a trailing stop order may not absolutely guarantee that the stock will be sold at a particular price.
The sell order is submitted to the sales floor, and then must be executed by a stock trader. Some larger brokerages also package buy and sell orders together. This can increase the time it takes to complete a trailing stop sell order. In an extremely volatile market, the stock price can change again before the sale is completed. Investors can limit their exposure by considering such delays when choosing the trailing stop order price.