Trailing Stop Limit Order

Trailing Stop Limit Order is similar to Trailing Stop Order, whereby the Trailing Stop Price will be “trailing” below or above the movement of the security’s market price, depending on whether it is on a long or short position, to maintain the set distance, which is either stipulated as an absolute dollar or as a percentage of the market price.

The main difference is that for Trailing Stop Limit Order, when the Stop Price is passed, the order will be converted into a Limit Order, whereas for Trailing Stop Order, it’ll convert into a Market Order.

Hence, for Trailing Stop Limit Order, when the market price hits or passes the Stop Price, the order would convert into a Limit Order to buy / sell the security at the specified Limit Price or better.

As a result, Trailing Stop Limit Order carries a big risk, as the order may never get filled if the market price is worse than the Limit Price. As a result, the position can continue falling with no more protection for the position. This makes Trailing Stop Limit Order a very insecure stop loss method, particularly for the extremely volatile stocks that often experience a gap up or gap down in prices.
Due to this risk, using Trailing Stop Limit Order to protect a position is not advisable.

Depending on the position on the market you have (long or short), there are 2 types of Trailing Stop Limit Order:
a) Sell Trailing Stop Limit Order (Trailing Stop Limit to Sell)
This is the trailing stop order when you have a long position on a security.
In this case, the Trailing Stop Price is placed at a set distance (e.g. Trailing Amount) below current market price of the security.
In addition, the Trailing Limit Price will also need to be specified as a certain distance (e.g. Limit Offset) from the Stop Price, whereby the Limit Price should be at a least the same or lower than the Stop Price.

The Stop Price will then rise as the market price increases (i.e. The Stop Price will be trailing the increasing market price from below: Stop Price = Increasing Market Price – Trailing Amount).
However, the Stop Price will remain the same (will not go lower) when the market price decreases.
Once the market price hits or passes Stop Price, the order would convert into a Limit Order to sell the security at the Limit Price (Limit Price = Stop Price – Limit Offset) or better (i.e. at Limit Price or higher, because for selling, the higher the price, the better).

b) Buy Trailing Stop Limit Order (Trailing Stop Limit to Buy)
This is the trailing stop order when you have a short position on a security.
In this case, the Trailing Stop Price is placed at a set distance (e.g. Trailing Amount) above current market price of the security.
In addition, the Trailing Limit Price will also need to be specified as a certain distance (e.g. Limit Offset) from the Stop Price, whereby the Limit Price should be at a least the same or higher than the Stop Price.

The Stop Price will then move lower as the market price decreases (i.e. The Stop Price will be trailing the decreasing market price from above: Stop Price = Decreasing Market Price + Trailing Amount).
However, the Stop Price will remain the same (will not go higher) when the market price increases.
Once the market price hits or passes Stop Price, the order would convert into a Limit Order to buy the security at the Limit Price (Limit Price = Stop Price + Limit Offset) or better (i.e. at Limit Price or lower, because for buying, the lower the price, the better)

Note:
When placing Trailing Stop Limit Order for an Option, the order will be triggered based on the market price of the option, NOT the market price of the underlying stock. Therefore, the Stop Price should be set based on the option’s price as well.

Therefore, just remember how the price of Call and Put options are related to the underlying stock price:
For a Call option, the option’s price increases when the underlying stock’s price increases, and decreases when the underlying stock’s price decreases (positive relationship).
On the other hand, for a Put option, the option’s price increases when the underlying stock’s price decreases, and decreases as the underlying stock’s price increases (negative relationship).

Example:
Suppose the stock price ABC is on a downtrend. You expect that the stock price ABC will continue to drop further. To take advantage of this opportunity, you short-sell the stock at $20, and place a Buy Trailing Stop Limit order with Trailing Amount = $0.3 and Limit Offset = $0.2.
In this case, the initial Buy Stop Price will be $20.3 and the initial Limit Price is 20.5.
When the stock price falls to $19, the Buy Stop Price will adjust accordingly to $19.3 and Limit Price to $19.5.
If the stock price continues to drop further to $18, the Buy Stop Price will adjust to $18.3 and Limit Price to $18.5.
Suddenly, the stock price stops to drop and begins to increase. In this case, the Buy Stop Price will remain at $18.3. Once the Stop Price of $18.3 is hit, the order will convert into a Limit Order to buy back the stocks at the price $18.5 or lower.
As with the risk of Stop Limit Order, this order may never get filled if the market price is worse than the Limit Price. Hence, the position can continue falling with no more protection for the position.
In this example, suppose the stock price gaps up to $27 and continue to increase, the order will never get filled. This makes Trailing Stop Limit Order a risky method for protecting a position / taking profit, and hence not advisable.

For the list of other types of order, go to: Types of Orders in Trading.

Related Topics:
* Free Trading Educational Video: Learn Technical Tips from Dan Gramza
* Option Greek
* Understanding Implied Volatility (IV)
* Understanding Option’s Time Value
* Learning Candlestick Charts
* Learning Charts Patterns