The Best Trailing Stop Loss is designed to protect gains by enabling a trade to remain open and continue to profit as long as the price is moving in the investor’s favor.
This way you can let the trend continue in your favor but lock in your profits once the stock turns around.
The trailing stop is a very useful exit for traders that simplifies the process of letting winners run but keeping losses small.
The Key To The Best Trailing Stop
The key to the best trailing stop is that it needs to be loose enough that the stock has room to trend upwards. But it cannot be too loose or you will give back too much profit when the trend changes.
For example, in the Tesla chart below, you can see that the 5% trailing stop is too tight. It doesn’t allow the trend to develop and we take too many trades instead of following the trend:
Which Trailing Stop Loss Should You Use?
I’m going to test a selection of them on historical data going back 30 years across more than 11,000 US stocks. We are going to use a new 252 DAY HIGH as a buy signal and then see which trailing stop produces the most profit while limiting risk. The trailing stop loss options we are going to test are as follows:
- Percent trailing stop
- ATR trailing stop (Chandelier)
- Moving average trailing stop
- Parabolic SAR trailing stop
1. Percent Trailing Stop
This is the simplest trailing stop. Whenever the stock trades X% below it’s in-trade high then we will exit the stock on the next day open. For example, if we buy Apple at $100 with a 20% trailing stop and it hits a high of $200 we will exit if the stock drops back to $160. The following table shows the effectiveness of the percent trailing stop following a new 252-day high in the Russell 3000 from 7/1990 to 1/2020:
As you can see, the 20% and 25% trailing stop produced the best return-to-risk scores with a reasonable win rate and profit per trade.
2. Chandelier Trailing Stop
The chandelier trailing stop uses the average true range indicator (ATR) to position the stop a certain number of points away from the action. The advantage of this technique is that it takes into account the volatility of the stock and places the stop a certain multiplier away. For example, if Apple is trading at $100 and we use a 5 x ATR(21) stop, the stop will be placed 5 times the ATR(21) below the recent high. If the ATR is $5 then the stop will be placed 25 points away (5 x 5). In this test we are going to use the 21-period ATR and vary the multiplier to test and see if it is Best Trailing Stop Loss:
3. Moving Average Trailing Stop
The moving average trailing stop works like this. Once we enter the trade (a new 252-day high) we will follow it with a simple moving average line. If the trend changes and the stock drops under the moving average line we will then exit the trade on the next day open. The following table shows our results across different moving average lengths:
4. Parabolic SAR Trailing Stop
The parabolic SAR indicator rises according to specified parameters. But unlike the usual trailing stop, PSAR continues to move higher even as the stock stays where it is or declines. This means there is an element of time involved so essentially, the stock is penalized for not continuing the trend upwards. The PSAR indicator is made up of two parameters, acceleration factor and max acceleration. These are usually set up as 0.02 and 0.2, however, I found those parameters to be too fast. The following table shows our results for various permutations:
The Parabolic SAR indicator produced some good return-to-risk scores particularly with small parameters (much smaller than most traders use).
Which Trailing Stop Works The Best?
The results shown above provide some answers as to which trailing stop works best in stocks.
- The best trailing stop by return-to-risk was the 20% trailing stop with a score of 0.57. This was followed by the 25% trailing stop and the 15% trailing stop.
- The best trailing stop according to average profit per trade was the 50% trailing stop with an average profit of 82.72%.
- The 50% trailing stop also had the highest win rate at 53.3%. However, the 50% trailing stop naturally has a high drawdown and trade duration.
- The Chandelier trailing stop did not perform particularly well with low return-to-risk scores across the board.
- The moving average stop was not particularly effective either.
- The Parabolic SAR indicator put in some decent scores according to return-to-risk.
- Overall, the 15%, 20%, 25% and Parabolic SAR trailing stops appear to work the best.
In this Premier Bull & Bear Blog Post, we looked at various types of trailing stops and tested them on 11,000 US stocks back to July 1990.
We found that the best trailing stop loss was the “percentage trailing stop” (particularly the 20% and 25%) does a decent job of capturing upward trends in stocks while limiting risk.
Meanwhile, the Chandelier stop and moving average line produced disappointing results and do not provide much reason to use these methods. These findings support my previous experience and it was no surprise to me that the percentage trailing stops performed strongly.
If there is a surprise in these results, it is the decent scores for the Parabolic SAR indicator. This trailing stop looks like it has some merit and can be effective with all three membership levels.
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