How Effective Are Stop-Loss Orders?

Follow us on LinkedIn

A stop-loss order is a type of order used in trading to limit an investor’s losses or to take a profit. It is an instruction to sell a security when it reaches a certain price level, known as the stop price. When the stop price is reached, the stop-loss order is automatically executed, and the security is sold at the current market price.

Stop-loss orders are a popular risk management tool for traders, as they help to minimize potential losses in the event of an adverse price movement. By setting a stop-loss order, traders can define their risk tolerance and limit their potential losses to a predetermined amount. A trailing stop-loss order can also be used as a profit-taking strategy.

Reference [1] examined the effectiveness of stop-loss trading strategies. It utilized 2 types of stop-loss strategies:

  • SL1: a sell order is generated when the price of the day is less than the average of 95% price over the previous three days.
  • SL2: a sell order is generated when the price of the day is less than 95% of the highest price of the previous three days.

The authors pointed out,

Our findings are consistent with those of Lo and Remorov (2017), who demonstrated that tight stop-loss strategies underperform the buy-and-hold policy in a mean-variance framework due to high trading costs. In a nutshell, this study confirmed that the return of SL2 strategy in quarterly makes higher profit in comparison with two other strategies.

We think that the results are interesting, but not conclusive. Also note that the studies have been performed on the Iranian stock market. It would be interesting to see the results from the developed markets’ perspectives.

As far as we’re concerned, we would limit the use of stop-loss orders since they make the PnL highly path-dependent, thus trading strategies become more complex to analyze. We prefer hedging strategies instead.

Let us know what you think in the comments below or in the discussion forum.

References

[1] Mohammad Amin Teimoori Boghsani, Abdolmajid Abdolbaghi Ataabadi, Majid Ameri, Effectiveness of Stop-Loss Trading Strategy VS. Buy-And-Hold Strategy: Evidences of Top 30 Companies at TSE, Preprint

Further questions

What's your question? Ask it in the discussion forum

Have an answer to the questions below? Post it here or in the forum

LATEST NEWSBiden is fighting with Republicans over whether to keep protecting the lesser prairie chicken and northern long-eared bat
Biden is fighting with Republicans over whether to keep protecting the lesser prairie chicken and northern long-eared bat

The long-eared bat is one of 12 bat types decimated by a fungal disease called white-nose syndrome.

Stay up-to-date with the latest news - click here
LATEST NEWSNOVARC TECHNOLOGIES NAMED TO THE GLOBE AND MAIL’S FIFTH-ANNUAL RANKING OF CANADA’S TOP GROWING COMPANIES
NOVARC TECHNOLOGIES NAMED TO THE GLOBE AND MAIL’S FIFTH-ANNUAL RANKING OF CANADA’S TOP GROWING COMPANIES

Novarc places #145 out of 425 companies based on three-year revenue growth of 330% VANCOUVER, CANADA, Sept. 29, 2023 (GLOBE NEWSWIRE) — Novarc Technologies Inc., a leading provider of advanced robotics solutions, announced today the company has placed No. 145 on the Globe & Mail’s 2023…

Stay up-to-date with the latest news - click here
LATEST NEWSAzerbaijan says it has invited UN mission to visit Karabakh 'in the coming days'
Azerbaijan says it has invited UN mission to visit Karabakh 'in the coming days'
Stay up-to-date with the latest news - click here
LATEST NEWSEutelsat Completes Merger With Oneweb, Forms Eutelsat Group With Bharti Enterprises as Largest Shareholder
Eutelsat Completes Merger With Oneweb, Forms Eutelsat Group With Bharti Enterprises as Largest Shareholder
Stay up-to-date with the latest news - click here
LATEST NEWSInvestors fear US data disruption from looming government shutdown
Investors fear US data disruption from looming government shutdown
Stay up-to-date with the latest news - click here

Leave a Reply