Market volatility has begun to pick up and the markets are experiencing much larger average daily ranges (average price range from high to low) in most of the futures markets.  For example, the E-mini S&P had a 14-point average daily range several weeks ago and now has an average range of 24 points.  On average, the E-mini S&P contract trades in a daily range that offers $1,200 from high to low per contract.  This creates great opportunities and means that we need a method to lock in profits as the market moves in our favor.  Trailing stops are a good way to protection profits in this type of market. Two popular types of trailing stops are manual trailing stops and automatic trailing stops.

Manual Trailing Stops

A manual trailing stop is moved by the trader as the market makes a new swing high or low.  This is a chart-based trailing stop and takes into consideration the market structure and trend.  In the chart in Figure 1, we will assume there was a short position taken near 1064.00 at (A).  The original protective stop was above the swing high at 1066.00 at (B).  After entering the position, the market sells off in our favor to point (C).  Then, it retraces back up to point (D).  During this time, our original protective stop stays in place.  When the market sells off and breaks the swing low at point (C), a new swing high has been created at point (D). 

At this point, we can safely move the protective stop to just above the last swing high at point (D).  The stop is placed at 1063.00.  This locks in a 1-point profit.  When the market drops below point (C), another swing low is created at point (E).  The market rallies back to point (F) and then sells off.  When the market sells off below point (E), a new swing high is created at point (F).  Immediately, the protective stop is moved from 1063.00 to just over point (F) at 1060.50.  Now, profits of 3.50 points have been locked in.  This process of manually trailing your stop continues as long as the trend moves in your favor.

With each new swing low, the last swing high is located (red arrows) and the protective stop is placed just above that.  Once the market breaks a previous swing high, we will be stopped out of our position with a profit.  The exact high and low of these moves will not be caught using a trailing stop.  However, we will let the profits run and catch the large percentage of these moves.

This is an excerpt from December 2009 issue of Trader's Journal.