Taming Momentum Crashes: A Simple Stop-Loss Strategy
52 Pages Posted: 12 Mar 2014 Last revised: 25 Sep 2016
Date Written: September 24, 2016
In this paper, we propose a stop-loss strategy to limit the downside risk of the well-known momentum strategy. At a stop-level of 10%, we find, with data from January 1926 to December 2013, that the maximum monthly losses of the equal- and value-weighted momentum strategies go down from -49.79% to -11.36% and from -64.97% to -23.28%, while the Sharpe ratios are more than doubled at the same time. We also provide a general equilibrium model of stop-loss traders and non-stop traders and show that the market price differs from the price in the case of no stop-loss traders by a barrier option.
Keywords: Momentum, crashes, downside risk, stop-loss orders
JEL Classification: G11, G14
Suggested Citation: Suggested Citation