How Stop-Loss Rules Affect Returns and Volatility

Summary

This note points readers to a study examining how stop-loss and profit-taking rules affect return distributions. It reports that stop-losses can reduce position volatility, but that hidden costs may offset the perceived benefit. The cited study finds no statistically significant difference in expected return from using stop-losses or profit-taking stops, separately or together.

The note also highlights that these rules can matter when returns have drift: expected returns may move toward those of the underlying position. It raises the broader question of when to use stops and whether their performance has been established through statistical backtests, with particular interest in European equities. However, it gives no test design, stop thresholds, sample details, or Europe-specific evidence, so it serves as a pointer to research rather than a complete evaluation or trading recommendation.

Key ideas

• Stop-loss rules can change the distribution of returns as well as reduce position volatility.
• The cited study reports hidden costs that can offset perceived benefits.
• Stop-loss and profit-taking rules showed no statistically significant difference in expected return in the cited study.
• With return drift, expected returns under stop rules may converge toward those of the underlying position.
• The note provides no European equity-specific results or details of the study's testing method.

Tags

# Any research paper on stop loss?


# Any research paper on stop loss?












Has there been any rigorous study on stop loss ? When to apply it?

Has it been shown to work through proper statistical backtests?

I am interested in Equities, preferably European stocks.

## Answer by vonjd (score 11)

https://quant.stackexchange.com/a/2786

I find this one very helpful:

Re-Examining the Hidden Costs of the Stop-Loss by Wilson Ma, Guy Morita, Kira Detko

Abstract:

> In this paper, we present general implications of the impact of stop-losses to future returns. The use of stop-losses change return distributions, but not in the way that one would typically expect. We find that while stop-losses can reduce position volatility, hidden costs offset perceived benefits in terms of altering future returns. Use of both stop-losses and profit-taking stops separately or in conjunction offer no statistically significant difference in expected return but have a meaningful impact in returns with drift, as the expected return converges to that of the underlying.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.