In this way the downside is limited by the stop level but the upside is potentially unlimited. In other words trailing stops are a way to allow profits to run and losses to be limited. In this article I describe how trailing stops work. I also test anecdotal evidence that trailing stops lower risk and result in higher profits.
This is done by running back tests on two vanilla strategies both with and without trailing stops. How they Work There are several variations of the trailing stop used by forex traders. The most common are described here. Standard trailing stop With the standard trailing stop the trader sets an activation profit threshold in pips. Unlike a regular stop loss the trailing stop will move as the price reaches new highs and the profit on the trade increases.
The reverse is true for a sell side position. The trailing stop will remain fixed if the price moves against the trade. The exit happens once the stop level is hit. The diagram above illustrates a basic trailing stop system. With the trailing stop the trader will also need to set a trail distance. With a dynamic trailing stop the placement of the stop can potentially move on every price tick. Whereas with an incremental trailing stop the level is only changed once the price changes by the pre-set step size.