While the Fixed Price Retreat Trailing Stop method uses the maximum retreat of a highest closing price as a reference price to stop loss or to take profit; Dynamic Trailing Stop uses a dynamic support as a reference.
The Dynamic Trailing Stop method is most suitable for stocks which are trending. Generally, the Bollinger Middle Band and the 14, 21, 31 EMA are quite effective as trailing stop reference.
When a stock price has just breaking away from a sideways consolidation, the Bollinger Bands is the best indicator, and the Bollinger Middle Band shall serve as the immediate trailing stop reference. As price risen for a few days, and begins to form a trend, investors should switch to 14, 21, 31 EMA as the dynamic trailing stop reference, for the 14, 21, 31 EMA could track a longer term uptrend.
This way, investors would not take profit too early and miss out the potential long term uptrend. In short, as long as the stock price is still above the dynamic trailing stop, investors should not take profit.
Examples:
Chart 1: AMMB – 1015, chart from 4/6/2009 to 29/07/2009.
As indicated by A, the Bollinger Bands re-expanded, with price above the Bollinger Middle Band, suggesting a beginning of a bullish biased movement after breaking away from a consolidation. Therefore, as indicated by B, the Bollinger Middle Band shall serve as the immediate trailing stop reference. If price should failed to stay above the Bollinger Middle Band, it is a signal to cut-loss.
In other words, if price should stay above the Bollinger Middle Band, there is a good chance that it might be forming an uptrend. However, there will be corrections and consolidation for a healthy uptrend, and price can not sustain an continuous rally. When using only the Bollinger Middle Band as dynamic trailing stop, price could break below the Bollinger Middle Band during a correction, and investors might could have taken profit too early. Therefore, when the conditions allow, investors should consider switching from Bollinger Middle Band to 14, 21, 31 EMA as the dynamic trailing stop. (Refer to Chart 2)
Chart 2: AMMB – 1015, chart from 17/6/2009 to 17/11/2009.
Although the Bollinger Bands is a reliable indicator, for the investor who are already in position, and making profit, they shall not need the Bollinger Bands to find buying signals anymore. But instead, they will need an indicator which could track a longer trend.
Arrow A, is the entry level by using the Bollinger Bands. When price begun to move up, trader switch to 14, 21, 31 EMA for a potential longer trend tracking. As long as price is still supported by the rising 14, 21, 31 EMA, there is no strong reason to take profit. And when price should break below the 14, 21, 31 EMA, it is time to take profit. As indicated by B, price of AMMB is still above the rising 14, 21, 31 EMA, which means that the uptrend is still intact.
Chart3: AMMB – 1015, chart from 28/07/2009 to 16/11/2009.
When using the 14, 21, 31 EMA as dynamic trailing top, many investors would ask a similar question. “There are 3 lines of MA, and which one should I follow to cut-loss of to take profit?” Please refer to the table below:
| Indication | Action |
| A | Stock price technically corrected, breaking below the 14-day EMA. For those investors who are already in position, should consider the broad market condition, and if the condition is still positive, this is just a short term warning signal, and investors can choose to keep their position. However, if one should feel uncomfortable, this is a signal to take partial profit, by selling 1/3 of the position, and keep the rest of the position for the uptrend is still intact. |
| B | After a correction, price rebounded, and resumed its uptrend. The 14, 21, 31 EMA continues serving as the uptrend dynamic support as well as the trailing stop reference. |
| C | Stock price technically corrected again, but still supported by t he 14, 21,3 1 EMA. |
| D | Despite several correction, the 14, 21, 31 EMA is still tracking the uptrend. |
Table 1:
As indicated by chart 3, by using the 14, 21, 31 EMA as a dynamic trailing, not only it can protect your paper profit, but also maximizing the potential uptrend return. When price should break below the 14, 21, 31 EMA, it means that the uptrend is no longer valid, thus a signal to take profit.
Conclusion:
Generally, when stock begins to move higher, the Bollinger Middle Band is a good signal for entering a position. If price should failed to stay above the Bollinger Middle Band after you bought your share, it is a signal suggesting that the uptrend has failed to form, thus a signal to cut-loss. When price started to move, it is time to switch to 14, 21, 31 EMA, to track a potentially longer uptrend, by maximizing the profit by delaying profit taking.
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