Dynamic stop-loss rules as universal performance enhancers

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This paper provides ample empirical evidence, using US equity and bond indices, why daily stop-loss rules can be considered as viable performance enhancers. While a longer-term stop-loss rule can help investors to avoid market crashes by being out of the market, investors may obviously lose on the up-market days too. Furthermore, a shorter-term stop-loss rule may not miss the good market days by allowing investors to stay for a longer time in the market at the obvious expense of increased risk and higher drawdowns. This paper illustrates how daily stop-loss rules can significantly outperform the buy and hold equity and bond benchmarks, their equally weighted portfolio and the trend following strategy, simple moving average, which is driven from those asset classes – for both long and short positions. The results are robust to a variety of variations on the initial theme and it’s shown that performance enhancements can come from a variety of other sources related to a static stop-loss rule.

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    • Figures 1-4. Cumulative return and maximum drawdown January 1, 2004 – October 13, 2015
    • Figures 5-8. Cumulative return and maximum drawdown January 1, 2004 – October 13, 2015
    • Figures 9-10. Cumulative return and maximum drawdown January 1, 2004 – October 13, 2015
    • Figures 11-12. SPY-SMA cumulative return and maximum drawdown January 1, 2004 – October 13, 2015
    • Figures 13-14. TLT-SMA cumulative return and maximum drawdown January 1, 2004 – October 13, 2015
    • Table 1. SPY summary statistics with daily stop loss January 1, 2004 – October 13, 2015
    • Table 2. TLT summary statistics with daily stop loss January 1, 2004 – October 13, 2015
    • Table 3. Summary statistics of SPY-TLT equal weight portfolio with daily stop loss January 1, 2004 – October 13, 2015
    • Table 4. Summary statistics of SPY-SMA with daily stop loss January 1, 2004 – October 13, 2015
    • Table 5. Yearly return of SPY-SMA with daily stop loss January 1, 2004 – October 13, 2015
    • Table 6. Summary statistics of TLT-SMA with daily stop loss January 1, 2004 – October 13, 2015
    • Table 7. Yearly return of TLT-SMA with daily stop loss January 1, 2004 – October 13, 2015
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Investment Management and Financial Innovations