Effective "Stop Loss" and other exit concepts

What's worked in my experience is the concept of closing positions when the EV (Expected Value) of the immediate future becomes negative, regardless of unrealized return; if it results in a net loss then it can be called a "stop loss" exit. There's the risk management idea of applying a purely negative unrealized-return based exit, which empirically hurts performance and doesn't always make sense.

EV is everything

Whenever market anomalies occur, and they always do, asset managers often lower over all exposures to potentially large negative swings. From a mathematical standpoint, when a potential loss becomes significantly large in the range of possible future outcomes, our EV has shifted negatively and it's time to get out. It takes discipline to pull off, and applies to everything in life going from investments, poker, to choice of study at the university.

True story:
A couple I've met through a friend had invested in a house in England in the mid 2000's during the boom, and decided to sell it a year ago. Of course with the economic contraction from the last couple of years, they haven't received any bids higher than the price they had paid. They simply have not budged on their offer, hoping to make a net profit, holding onto the hope that "real estate prices always move up...".

With the European sovereign debt crisis , EV is very negative for the change in British property values in the coming years. And we can see that in real life, it takes tremendous discipline to make the sacrifice of taking a net loss in order to avoid a potentially devastating financial blow. Most people can't do it.

Solutions for financial trading around stop-loss exits

1. Arbitrage: Risk management around these types of trades are more about liquidity, execution, and IS (Implementation Shortfall). These areas are usually more easily manageable.

2. Options: Options can be used to massage open positions to lock-in unrealized return while still leaving potential for further gains.

3. Option vertical spreads: No more need for hard stop-loss or take-profit orders when you can decide risk/reward numbers ahead of time regardless of how far the underlying moves in either direction.