Stop Loss Dangers
We use stop losses as an additional layer of risk management for individual stock positions in some of our momentum strategies. However, the way in which we implement our stop losses is unique. Most stop losses are set via computer-based software and are triggered automatically when the stop price is hit. Automatic stops on today’s exchanges are dangerous. More than 60 percent of trading on U.S. stock markets is now attributable to high-frequency, algorithmic programs that can move markets violently. Take August 24, 2015 as an example: |
As you can see from the table above, some major stocks and ETFs crashed 15 to 50 percent intraday before regaining almost all of their loses before the end of the day. Most of the losses were generated in around one hour. Those that used computer-based stops automatically exited the market, with a very slim chance of re-entering at prices anywhere near their exits. We take a different approach: when a stop loss is generated by our strategy for a given stock based on end-of-week data, it is likely that a couple of days have passed since the stop price signal was generated by our system, since we use weekly signals. Also, we would exit that position no sooner than the following Monday. This built-in delay helps our strategies avoid automatic losses created by flash crashes. Because we do not have standing orders and we manually execute our stop loss trades, we always have an opportunity to evaluate the situation before any of the positions in our investors’ accounts are exited. |