Dynamic stop-loss rules as universal performance enhancers

Dimitrios D Thomakos ,Rafael Yahlomi

doi:10.21511/imfi.15(2).2018.01

Abstract

This paper provides ample empirical evidence, using US equity and bond indices, why daily stop-loss rules can be considered as viable performance enhancers. While a longer-term stop-loss rule can help investors to avoid market crashes by being out of the market, investors may obviously lose on the up-market days too. Furthermore, a shorter-term stop-loss rule may not miss the good market days by allowing investors to stay for a longer time in the market at the obvious expense of increased risk and higher drawdowns. This paper illustrates how daily stop-loss rules can significantly outperform the buy and hold equity and bond benchmarks, their equally weighted portfolio and the trend following strategy, simple moving average, which is driven from those asset classes – for both long and short positions. The results are robust to a variety of variations on the initial theme and it’s shown that performance enhancements can come from a variety of other sources related to a static stop-loss rule.

Highlights

Stop-loss rules are a risk management tool, which can help practitioners to control their risk by covering their positions and rotating to safety assets such as cash, short-term treasury bills, etc
This paper provides ample empirical evidence, using US equity and bond indices, why daily stop-loss rules can be considered as viable performance enhancers
While a longer-term stop-loss rule can help investors to avoid market crashes by being out of the market, investors may obviously lose on the up-market days too

Summary

Introduction

Stop-loss rules are a risk management tool, which can help practitioners to control their risk by covering their positions and rotating to safety assets such as cash, short-term treasury bills, etc. Being out of the market can be risky too when missing positive (negative) days for investors with long (short) positions. For these periods where the volatility and drawdown dominate return in a market, investors may consider that he might obtain potential performance enhancements by the use of the stop-loss trading rules on the portfolio or strategy of an investor. In terms of its practical relevance, it shows that finance practitioners do not have to wait being out of the market for protracted periods of time – and this is important as is discussed below, missing some of the good days can destroy the return profile of an investment strategy

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Conclusion