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What is a trailing stop limit? How can it generate explosive investment returns? Read on. A trailing stop limit is simply a stop loss order, but one with a very important difference compared to a traditional stop loss order. A traditional stop loss order is a command to your broker to sell a stock holding when it drops below a preset price.

For example, say you hold 1,000 shares of Microsoft (MSFT) corp that you bought at $10.00 a share. You can tell your broker to sell those shares if the stock ever drops below a price that you feel comfortable with, for example $7.50. That way you limit any potential losses on your position.

There is a problem with a traditional stop loss order however, and I’m sure you’ve spotted it already. What happens if Microsoft corp shows impressive gains for a year, say it increases its share price to $18.00? That’s great, but your stop loss order is still set at $7.50, so if MSFT corp’s stock then drops back down you’ve protected yourself against a 25% loss in your original position, but you haven’t protected your gains at all.

A trailing stop limit changes that for you. A trailing stop limit order actually changes the number at which it goes into effect as the stock price changes. That buys you a very important benefit as an investor. It protects you against loss, but also allows you to make a nice profit while doing so. Basically it mitigates a certain measure of risk while maximizing your investment returns. Anything that mitigates investment risk while allowing an investor to generate potentially explosive returns is a great thing.

For example, say you have the same position in MSFT that you got into at the same $10 / share price, but this time you used a trailing stop limit. If you used a 25% trailing stop limit, it would increase so that any time the stock dropped 25%, a sell order would be triggered. That way when the stock went to $18.00, then dropped back down, much of your profit would be preserved. Your loss would be limited to a maximum of 25% of the stock’s highest market price. In this example, your sell order would have been triggered at $13.50 / share.

So, instead of your position being liquidated at $7.50 and you losing all your profit on the stock’s increase, plus part of your original stake, you would lock in some profit, in this case a 35% gain. When setting up a trailing stop limit order you can usually specify either an trailing amount or a percentage. In this example you could have chosen the 25%, or you could have chosen an actual dollar amount, such as $1.50. If you chose to use the dollar amount, your sell order would have been triggered at $16.50.

If your broker offers both options you’ll be free to choose whichever suits your particular position and mental state the day you make the order. If you’re setting the trail using a dollar amount, you’ll typically have a limit price and an optional offset. The limit price moves up and down with the market price and that’s what’s used to trigger the sell order. The offset, if you use one, is an additional amount that’s subtracted from the trailing limit, say .25, to arrive at your actual sell order price.

Using a trailing stop limit can generate explosive gains for your portfolio because you will maximize gains in your stocks, while minimizing losses. Any time you can do that, you’ll be retired on a beach in Maui that much sooner.

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