Exit strategies are a vital component of forex trading, which helps restrict and minimize trade loss risk. In fact, the absence of appropriate exit strategies could be catastrophic for an investor. A trailing stop is one such forex exit strategy, which entails moving the stop loss level when a trade progress favorably.

Understanding How a Trailing Stop Works

Trailing stops are often used in conjunction with stop-loss orders. To set up a trailing stop successfully, it is important first to determine a stop loss. A stop-loss order involves setting a dollar amount that is lower than the current trading price of the currency. When the currencys value reaches this specified price, a stop-loss order is activated, and the currency is sold.

A trailing stop also entails setting a stop loss value. However, in this case, the sell stop price is not a dollar amount but is expressed as a percentage lower than the current market price. For instance, the current market price of a currency is $40, on which a 10% trailing stop is determined. In this case, the trailing stop will get activated when the currency's market price reaches $36 ($40 - 10% of $40).

It must be noted that a trailing stop moves in the direction of a price rise. In the above example, if the currency's price increases to $44, a trailing sell stop level will be set at $39.6 ($44 - 10% of $44). It must also be noted that a trailing stop only goes up and does not follow a price if it falls.

Feasibility of a Trailing Stop

Determining the feasibility of a trailing stop and other forex exit strategies is an intricate task, which will depend on your desired level of risk-return payoff. Broadly speaking, a trailing stop is a better exit strategy than a stop loss, offering scope for higher profitability.

However, you will only be able to optimize your forex trading systems when the percentage of a trailing is wide enough to counter the effects of random noise and normal fluctuations in the market.