Optimal trading with a trailing stop

DOI10.1007/S00245-019-09559-0zbMATH Open1471.91545arXiv1701.03960OpenAlexW2949744683WikidataQ128336979 ScholiaQ128336979MaRDI QIDQ2020306FDOQ2020306

Authors: Tim Leung, Hongzhong Zhang 

Publication date: 23 April 2021

Published in: Applied Mathematics and Optimization (Search for Journal in Brave)

Abstract: Trailing stop is a popular stop-loss trading strategy by which the investor will sell the asset once its price experiences a pre-specified percentage drawdown. In this paper, we study the problem of timing buy and then sell an asset subject to a trailing stop. Under a general linear diffusion framework, we study an optimal double stopping problem with a random path-dependent maturity. Specifically, we first derive the optimal liquidation strategy prior to a given trailing stop, and prove the optimality of using a sell limit order in conjunction with the trailing stop. Our analytic results for the liquidation problem is then used to solve for the optimal strategy to acquire the asset and simultaneously initiate the trailing stop. The method of solution also lends itself to an efficient numerical method for computing the the optimal acquisition and liquidation regions. For illustration, we implement an example and conduct a sensitivity analysis under the exponential Ornstein-Uhlenbeck model.

Full work available at URL: https://arxiv.org/abs/1701.03960

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zbMATH Keywords

optimal stoppingdrawdownstop losstrailing stopstochastic floor

Mathematics Subject Classification ID

Financial markets (91G15) Stopping times; optimal stopping problems; gambling theory (60G40) Financial applications of other theories (91G80)

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Cited In (3)

• Recursive algorithms for trailing stop: Stochastic approximation approach
• A probabilistic analysis of the trading the line strategy
• Exit problems for positive self-similar Markov processes with one-sided jumps

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