Assessing Stop-Loss and Re-Entry Strategies

Abstract

Stop-loss strategies are used by many practitioners to limit excessive losses on existing investments. In practice, however, the value of stop-losses can only be assessed when re-entry rules are considered jointly with stop-loss rules. In this paper 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 indices 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.

Keywords: Stop-losses, Re-entry, Stopping Premium, Return Enhancement, Volatility Reduction

JEL Classification: G10, G11