Using Trailing Stops In Exit Strategies by J. Katz, Ph.D., and D. McCormick
Last issue, we saw a demonstration of how an exit strategy can affect the performance of a trading system. This time, we will discover how to measure the impact of exiting the market by using trailing-stop techniques.
Previously, we explored the behavior of a simple exit strategy involving a profit target exit, a stop-loss exit and a time-based exit. We used a standardized random entry system in which a random number generator
provided us with entries into positions from which we could exit. Our goal was to find out how an exit strategy could improve the performance of a system whose trade entries were essentially random.
This exercise demonstrated that a proper combination of even simple exit methods such as fixed dollar-amount stop-losses and profit targets can substantially improve the behavior of a trading system — even turning a random, losing system into a profitable one! Employing stop-losses and profit targets of the wrong sizes can ruin a trading system, making it perform significantly worse than it would have otherwise. Finally, although there is some interaction between the entry method and the behavior of the exit strategy, there is also much similarity across entry methods in the behavior of the exits.