Stop-loss strategies with serial correlation, regime switching, and transaction costs

Stop-loss strategies are commonly used by investors to reduce their holdings in risky assets if prices or total wealth breach certain pre-specified thresholds. We derive closed form expressions for the impact of stop-loss strategies on asset returns that are serially correlated, regime switching, and subject to transaction costs. When applied to a large sample of individual U.S. stocks, we show that tight stop-loss strategies tend to under perform the buy-and-hold policy in a mean-variance framework due to excessive trading costs. Outperformance is possible for stocks with sufficiently high serial correlation in returns. Certain strategies succeed at reducing downside risk, but not substantially. (C) 2017 Elsevier B.V. All rights reserved.