Visualization of stop-loss adjustments for buy-and-hold investment strategy

Alex Gaggin
December 26, 2015

Passive investing principles

It's a known fact that it's very hard to beat markets. Thus the practical thing that a private investor can do is to ride the market instead of competing with it - buy a pool of investments that represent the whole wide market, and keep to it.

  • It's simple thing to do.
  • It provides reasonable returns long-term.
  • Dividends will augment returns.
  • But, it only works for long term, as there were years of market's stagnation or even decline.

Stop-loss alternative strategy

Is it possible to wait out crash periods and re-enter market once it's growing again? Here's a very simple strategy.

  • All funds are kept either as cash, or invested in SPY exchange-traded fund, which follows S&P 500 index in composition and price dynamics.
  • It's one of the most actively traded stocks, so spread (ask/bid difference) shouldn't be harsh (it's not taken in account in the following simulation).
  • Stock is purchased when current price is higher than moving average by specified percent.
  • Stock is sold if it's plunged by specified percent from last price maximum since purchase.

Influence of model parameters

See how particular drops in stock price are avoided by this strategy by adjusting parameters in a web-app:

  • period of moving average (longer period - lower sensitivity to price movements),
  • difference between current price and average when buy decision is triggered (higher difference means higher certainty that the market grows, but slower reaction as well),
  • drop of price from last maximum after stock purchase event (deeper drop - higher degree of certainty that market is going down, but also higher loss from this drop),
  • investment start date (up to current moment),
  • broker fee and starting capital.

Sensitivity analysis

As data shows, selling after 10% drop isn't as profitable as waiting for even more evidence of a recession. But then again, more sensitive drop trigger has psychological advantage - losses don't seem as big at the crisis time.

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