A:

Trailing stop orders are used to limit losses and protect profits on a stock position. You should use trailing stop orders on your positions when you know that you will not have access to your trading platform. You should also use a trailing stop order when you are getting emotionally attached to your position.

A trailing stop order is similar to a stop order. However, a trailing stop order tracks the stock price and the order changes by a specified percentage if the stock's price increases or decreases. The stop order becomes a market order after the stock price reaches the stop price.

For example, suppose you are long 500 shares of Facebook Inc., which you purchased for $25 a share in July 2013. Your long position increased by 323% as of April 17, 2015, and closed at $80.78. Suppose Facebook reports its quarterly earnings on April 22, 2015. Assume that you are expecting weak earnings, and you want to protect these profits. However, you are nervous about selling the stock because you are emotionally attached to it.

You could use a trailing stop order in this case to limit your losses and protect your investment. You enter a good until canceled 10% trailing stop order before the earnings date. Therefore, if the stock declines by 10%, the stop order is triggered, thereby protecting your profits.

The trailing stop is set at $72.70 ($80.78 - (0.10*$80.78)). However, as the stock price moves up, the trailing stop price increases as well. Assume Facebook's stock price increases to $85, the subsequent trailing stop order then increases to $76.50.

Suppose that Facebook closes at $85 the day it releases its earnings and drops 11% during after-hours trading due to weak earnings and guidance. In this scenario, your trailing stop order would be triggered. Assuming you were immediately filled, you would sell your shares at $75.65 ($85-($85*0.11)).

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