Strategy backtest pt.3 - stop loss

In the past I didn't care much about properly set stop loss limits - until I made huge losses on some trades. So it was about time to find a strategy for my stop losses.


Before investigating the SL/TP with my tool, I checked on the trades of other users, to find their SL strategy. Information about such trading details are not directly provided by etoro, but can be determined by analyzing closed trades thoroughly. What I found were many different approaches: For example @moosgruber works predominantly with trailing stop losses, while @smartandsocial always works with a constant SL of approx. 1%. There was no clear trend visible to me (like "most traders use a 4% fixed stop loss"), so I started my investigation open minded.

Therefore I choose three different approaches:

1. A fixed ratio for SL and TP, which is calculated on trade opening. I choose 2% for SL and 10% for TP.
2. "Reinforced" SL/TP: When a trade is already running and another "buy" signal occurs, SL & TP are calculated again and changed, as if a new trade was opened. This is not an automatic option on etoro but must be done manually.
3. trailing stop loss with the same initial SL-rate. TP is not changed after trade is opened.

I combined those with the three most powerful entry signals from my last backtest: MACD, Stochastics and the rate of the Ger30 (see this older post for details). Again I focused on "long" trades and one running trade at a time.

Before we discuss the results, let me give you a few comments on stop loss in my backtesting tool: Right now I am working with daily market data, that means open-, high-, low- and close rate. Based on this data I cannot know the rate course during the day, especially whether the high or low rate is achieved first. On a day with high volatility it is possible that both stop loss and take profit limits are reached. Since I do know which one is reached first I always assume the worst case. That means the rate goes from open -> low -> high -> close. For the trailing stop loss I assume the following behavior: open -> low -> high -> low -> close. This should again be worst case. I first check on the old SL with the low rate, than adjust SL with the high rate and check again if the new SL is now triggered by the low rate. If so, the trade is closed on the low rate.

Now lets have a look at the results of the investigation. As in my last post they are shown in form of the DPI:



It is obvious that the stop loss system has a major impact on the result of the overall trading system. One out of the investigated systems was able to beat the DAX in the time from 1992 to 2004: Open on increasing rate and close on "reinforced" stop loss. Here are some further findings:

• Although the last of the shown strategies is overall profitable and better as buy-and-hold, it still has 4 years of loss. In the year 2000 this loss is even higher compared to buy-and-hold.
• None of the systems was able to prevent losses in the bearish years between 2000 and 2002, but "MACD trailing", "Stoch. fixed" and "Stoch. trailing" managed to have lower loss than buy-and-hold.
• Overall trailing was always the worst stop loss system in my investigation
• While combined with MACD and rate the reinforced SL was most powerful, with the Stochastics the fixed SL performed better.
• In bearish 1994 the best result was obtained with a Stochastics with fixed SL

My conclusion is that the stop loss system has a major impact on the overall performance. Though it is not possible to give a general answer which stop loss technique works best. It always has to fit in the trading system.

***

Related posts:

Strategy backtest pt.9 - "past performance is not an indication of future results"
Strategy backtest pt.4 - short trades

strategy backtest pt.2

Evaluating the strength of a trading strategy
First trading strategy backtest

***

Important remark: The results presented above and throughout my blog are no recommendation for your trading! I only share my personal findings and opinions to give ideas and let my followers and copiers know what I am currently working on. I can not guarantee the correctness of my calculations and my presented results. Furthermore past performance is not an indication for future results. Only trade with money you are prepared to lose!