Are Stop-Loss Orders Effective in the Cryptocurrency Market?

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Stop-loss orders are trading directives utilized to preset a price point at which a trade should be automatically closed. Traders use these orders to define a specific exit level for their positions, which is activated if the market price reaches or surpasses this pre-established point. Essentially, stop-loss orders serve as risk management tools to limit potential losses by exiting a trade when market conditions move against the trader’s position.

As previously discussed, the efficacy of stop-loss orders in equity trading remains a subject of debate. Reference [1] extends this inquiry into cryptocurrency trading, assessing the effectiveness of stop-loss orders in this context. The authors pointed out,

We provided evidence that the stop-loss rules turn momentum returns positive. For instance, the cross-sectional and time series momentum strategies provide monthly returns of -8.024% (t-stat =-2.221) and 3.340% (t-stat = 0.802) respectively but stop-loss momentum strategy provides 9.127% returns (t-stats = 4.054). The stop-loss avoids huge crashes to which other traditional strategies are exposed to. Such that the average of 10 largest crashes amount to -75.131% and –44.097% respectively for traditional momentum strategies but they reduced to 11.527% and 6.574% by the stop-loss momentum strategy. This is also the first study that used Liu et al. (2022) for the momentum returns for cryptocurrencies that provided the evidence of efficacy of using stop-loss for the momentum strategy. As, the alpha for stop-loss momentum strategy is 5.70% which is superior to any other momentum strategy. We provide evidence that the stop-loss momentum strategy has better yields in different market states.

In summary, the article highlights that,

• Unlike other asset classes, the cryptocurrency market does not exhibit momentum;
• Furthermore, it suggests that stop-loss orders are effective within the cryptocurrency market.

This finding came as a surprise to us. Let us know why you think stop-loss orders work in the cryptocurrency market in the comments below or in the discussion forum.

References

[1] Mohsin Sadaqat, Hilal Anwar Butt, Stop-loss rules and momentum payoffs in cryptocurrencies,  Journal of Behavioral and Experimental Finance Volume 39, September 2023, 100833

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