Investment Management: When to Hold ‘Em—When to Fold ‘Em

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During the last week, a few newsletter readers had questions about the use of sell stops as they pertain to my trend tracking methodology.

Here’s one e-mail:

I have some mutual funds that are in nose bleed territory, and I have mental sell stops which are about 6-8% below current price.

How do you suggest handling these individual funds, which appear to be subject to greater drops than the average fund? If I should buy a new fund/ETF, how can I best protect myself and keep my possible loss to a minimum?

Also, you mentioned in one of your articles setting an upside and a downside sell point. Could you elaborate?

Let me clarify, since this is an important issue.

For domestic funds/ETFs, your trailing stop should be 7% below the “high price” the fund/ETF made “after” you bought it. You don’t compute it from the current price, unless you just purchased it.

Also, be sure to consider any fund distributions since they have an effect on your sell stop point. I’m not sure what you mean by your funds being in nose bleed territory; if you use the sell stop discipline, this will never happen.

When selecting funds, use the StatSheet as a guide and make your selections based on your risk tolerance. In other words, if you are conservative, don’t pick very volatile sector or country funds.

The upside sell on any of your funds would be the trailing stop loss (7%), which eventually will get you out of the market, provided you follow the signal. Or, if our TTI (Trend Tracking Index) gives a sell first (unlikely) then that would be the overriding factor.

The downside sell occurs if the market goes straight down after your purchase of a fund/ETF; the 7% sell stop will serve to limit your losses.

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