Assessing Stop-Loss and Re-Entry Strategies

Abstract

Many practitioners use stop-loss strategies to limit excessive losses on existing investments. In practice, however, the value of stop-losses can be assessed only when re-entry rules are considered jointly with stop-loss rules. In this article, we analyze the benefits of joint stop-loss and re-entry rules from the perspective of both risk reduction and return enhancement for six different global equity markets, as well as for listed real estate investments, a commodity index, and gold. We find that stop-loss rules significantly reduce volatility and excessive losses. The evidence on return enhancement, however, is mixed, with stop-losses increasing absolute and risk-adjusted returns for most equity markets and listed real estate but not for commodity indexes or gold. We also find significant differences between secular bull and bear markets, with stop-loss and re-entry rules providing higher risk-adjusted returns during secular bear markets but not during bull markets.

TOPICS: Risk management, security analysis and valuation