Trailing Stop-Loss and Re-Entry Strategies in Europe

A stop-loss order is a method that can be used by investors to limit downside risk and can be explained by investors’ loss aversion. Loss aversion refers to the widely studied psychological phenomenon where expected losses have a greater impact on the investors’ preferences than expected gains. The use of stop-loss rules allows for this asymmetric profile. The stop loss hypothesis, also, states that higher returns can be obtained by limiting the downside risk of long positions. A stop-loss order can be established at a percentage of the asset value that grows over time as it rises, stopping if the asset value starts to go down (trailing stop-loss order). In this work, it is used trailing stop-loss orders (with a difference to the asset market value of 3%) with long positions in financial markets. After being stopped out in a down market, the re-entry rule is to buy the asset again as soon as the market grows by at least 3%. Whenever the portfolio is sold out by applying the trailing stop-loss rule, the investment is held in cash until the trigger is set off. In this article the rules are applied in Germany, France, Spain, and Greece during the financial crisis, to make an empirical validation of trailing stop-loss rules and re-entry rules for these markets. It was found that the followed strategy presents mixed results, proving to beat the buy-and-hold strategy in some scenarios of rising and falling prices. But the most important result is to generate fewer losses in very volatile scenarios such as Greece in 2014.