Abstract

https://ssrn.com/abstract=2895437
 


 



Optimal Trading with a Trailing Stop


Tim Leung


University of Washington

Hongzhong Zhang


Columbia University

January 8, 2017


Abstract:     
Trailing stop is a popular stop-loss trading strategy by which the investor will sell the asset once its price experiences a pre-specified percentage drawdown. In this paper, we study the problem of timing buy and then sell an asset subject to a trailing stop. Under a general linear diffusion framework, we study an optimal double stopping problem with a random path-dependent maturity. Specifically, we first derive the optimal liquidation strategy prior to a given trailing stop, and prove the optimality of using a sell limit order in conjunction with the trailing stop. Our analytic results for the liquidation problem is then used to solve for the optimal strategy to acquire the asset and simultaneously initiate the trailing stop. The method of solution also lends itself to an efficient numerical method for computing the the optimal acquisition and liquidation regions. For illustration, we implement an example and conduct a sensitivity analysis under the exponential Ornstein-Uhlenbeck model.

Number of Pages in PDF File: 26

Keywords: trailing stop, stop loss, optimal stopping, drawdown, stochastic floor

JEL Classification: C41, G11, G12


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Date posted: January 10, 2017  

Suggested Citation

Leung, Tim and Zhang, Hongzhong, Optimal Trading with a Trailing Stop (January 8, 2017). Available at SSRN: https://ssrn.com/abstract=2895437 or http://dx.doi.org/10.2139/ssrn.2895437

Contact Information

Tim Leung (Contact Author)
University of Washington ( email )
Lewis Hall 217
Department of Applied Math
Seattle, WA 98195
United States
9253381749 (Phone)
HOME PAGE: http://faculty.washington.edu/timleung/
Hongzhong Zhang
Columbia University ( email )
3022 Broadway
New York, NY 10027
United States
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