On the Efficacy of Stop-Loss Strategies

Abstract

Standing stop orders, or “stop-losses,” automatically sell out of equity positions to prevent capital losses from exceeding a predetermined threshold. This practice is commonly believed to not only limit downside, but also contribute to long-term portfolio growth. We test this theory by applying stop-losses to the MaxMeasures portfolio selection strategy, and to a bootstrapped backtest of arbitrary strategies on the S&P500 between 1969 and 2012. We find these simplistic stop-losses to be ineffective and generally detrimental to long-term performance.

TOPICS: Security analysis and valuation, quantitative methods