How to use trailing stops

I’m not going to mention the fall of Athens this week … Nor the ruin of Rome … nor the spiraling costs of borrowing across many Eurozone nations …

You’ve probably already guessed that these stories aren’t going away in a hurry. And we just have to get used to “crisis” as a state of normality in the global markets.

This means volatility.

And it means that we can’t expect to see the return of long-term bull markets for the foreseeable future.

So, what does that mean to us as investors?

• It means that there are huge potential profits available in the markets.

• It means that we need to use stop losses carefully and intelligently to protect ourselves from volatility, while avoiding being bumped out of every trade.

• It means that we need to rethink our long-term investment strategies.

• And it means that we should be thinking out of the box when it comes to diversifying our investments.

These are exactly the things that I’d like to look at today.

First off, a way of using stop losses to get the most from the huge moves we’re seeing in the markets, while protecting ourselves from sudden reversals.

And second, I’d like to tell you about a long-term hold that has the kind of potential you won’t find in any stockmarket. It’s something that is lining up nicely to be the next commodity boom.

More on that in a moment …

The problem with volatile markets

The kind of volatile markets we’re seeing at present can bring out the green-eyed monster in us traders.

We see these huge moves – and we want to get a piece of that action.

Problem is that the market is unpredictable, and too often we get knocked out of our trades by the very sizeable bumps in the road – before we can ride the big move.

So, how can we profit from big moves, without widening our stop losses to dangerous levels?

The trading technique I want to look at is trailing stops.

Locking in profits

Trailing stops is a term banded about a lot by traders. And yet, when I speak to individuals, I’m surprised how rarely they are actually used.

A trailing stop is a dynamic stop loss that reacts to the price of the instrument you’re trading.

Let’s say that you’ve bought EUR/USD at 1.3650, and put your stop in 20 pips below at 1.3630.

Now, let’s say that the price moves up to 1.3680, bringing you 30 pips into profit.

If your stop loss is a trailing stop, it will move up with the price – so your new stop loss level will now be 30 pips higher, at 1.3660.

In this way, your trailing stop has locked in some of those profits, so if the market suddenly turns tail in the other direction, before you’ve taken your profits, you’ll still have secured some profits on this trade.

The benefits are two-pronged – you’re protecting profits that you’ve already made AND you’re leaving yourself in the market to benefit from further gains.

However, that’s not to say that there aren’t disadvantages to the use of trailing stops (I’ll come to these in a moment).

Here’s an example of how trailing stops can magnify our returns …

In this example, we’re able to make the most of a big move, even though we’re not watching the charts all day and monitoring our position.

In this next example, you can see how it can protect us from a sudden turnaround …

Here, the unexpected – a bleak forecast from the governor of the Bank of England – sent markets the wrong way. However, instead of losing 20 points on this trade, which is what would have happened with a normal stop loss, it managed to secure a 20 point profit.

Behaviour management

Trailing stops do offer us some great benefits, however those benefits are often more psychological than monetary.

While a trailing stop offers protection from sudden reversals, and lets us profit from big moves – it doesn’t always work in our favour. Often (and this is particularly true in a volatile market) a trailing stop will see us knocked out of a trade that would have run through to its profit target if you’d used a normal stop loss.

However – and this really shouldn’t be underestimated – a trailing stop allows us the luxury of asking “What if I let my position run?” And it offers us security from the “What if disaster strikes?” worry.

This can prevent impulsive behaviour – like leaving trades open beyond their profit targets, or nervous behaviour, like closing trades early, before targets have been hit.

I don’t believe that trailing stops are the best solution for all traders, but I do think it’s worth having an understanding of them, and testing them out on your trading strategy to see whether they have a beneficial effect on your results.

Now, I promised you some details on a long-term investment opportunity that’s caught my attention …

That long-term hold …

Just this week, Mervyn King has painted us a grim picture of the UK’s economic recovery. Rising fuel costs and unemployment figures do nothing to alleviate the pain.

So, if you were hoping for a return to the days of sitting on your buy-and-hold stocks, while their value steadily grew – you might be waiting a long time.

Remember when the value of your house went up by 10s of £1,000s each year, while you did nothing more than give it a lick of paint? Well, those days are over – and so are the days when you could see the value of your shares grow, with little or no effort on your part.

The only way to protect ourselves from this drain on our money is to think smarter about our long-term investments – to hunt out the next hot tickets.

And they don’t come much hotter than a seriously undervalued new “commodity” that’s poised to be snapped up by every major company. In fact, firms have already begun to stockpile this.

This is an opportunity to get in at the beginning of a big investment story.

Next week I’ll be bringing you a full report this long-term investment that could take pride of place in your portfolio over the coming years.

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