Whipsawed? Now What?

Ulli Uncategorized 12 Comments

In the last couple of posts, I talked about the implementation of the trailing sell stop strategy and how to handle distributions.

A sell stop is a vital part of protecting the bulk of your portfolio in case of sudden trend changes. Of course, the other side of the coin is that you may get stopped out, the trend reverses again, and prices head higher leaving you on the sidelines.

That’s a classic whip-saw and simply the price you have to pay in order to not go down with the sinking ship as many did last year and in 2000.

Reader Wade had this comment:

Yes, sell stops work to get out of the market with minimal damage, but what type of rule do you follow to get back in after the market turns around?

First, let me clarify that this is not an exact science, there is a little bit of guesswork involved.

Let’s use an example of how you might find a new entry point. Say, you bought an ETF at $10 and the price, over time, rises to $11.00, which becomes your high point from which to measure your 7% trailing sell stop. That would make your trigger point around $10.23.

Let’s assume that this sell stop gets triggered and you get out of the position at around the above price, give or take a few cents. Now the trend reverses again and prices head higher with your old ETF now crossing the $10.60 level.

You have decided that you like this ETF and want to establish a new position, but when and at what price point?

As I said, there is no hard and fast rule that guarantees a positive outcome. Trend tracking is based on jumping aboard funds/ETFs as they are advancing and showing strong upward momentum.

Personally, I would consider re-entering once the old high has been taken out. In this example, it means prices have to break above the $11.00 level before I make a new commitment.

While that does not give you any assurances, you are entering at least with the trend being on your side. At the same time, you need to establish a new sell stop point in case this turns out to be another head fake.

My point is that you are better off keeping your emotions in check by following a methodical approach for dealing with these uncertainties than going by the seat of your pants.

I firmly believe that if you have a plan in place as to when to buy, when to sell and how to deal with whip-saws, your investment life will become much calmer.

At that time, you no longer need to listen to the hyped-up cheerleaders on the financial news stations promising and touting anything just to keep you tuned in for the commercial messages.

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Comments 12

  1. I found todays blog enlightening because I had never thought about getting back into the same stock I sold but thought your rule of thumb to buy back is excellent should I decide to buy it again. Using your 7% stop loss, saved me lots of money last year when I sold a stock at $53.71 losing a couple of dollars a share but was a drop in the bucket considering the same stock then dropped to $5.98 over the next 12 months, so using your technique saved me from disaster.
    So glad you stress the stop loss. It is engrained in my mind.

  2. climbing a wall of worry -S&P; 500: Now More than 20% Above Its 200 Day Moving Average-First time in 25years.

    Time to consider protection? How about buying call options on SDS or DXD with a strike out to jan10?

  3. Ulli,

    A big wow to this last Anonymous person talking about call options and I can see why they remained anonymous. Boy what a great way to lose money. People never cease to amaze me with all the ways they come up with to lose money and this is another great one.

  4. *sigh* Anonymous, I wish I knew what the heck you were talking about…

    Ulli, again, thank you for offering these techniques…
    /Chris

  5. I use a 5% gain as a decision point to re-enter. Of course the overall market and sector trend is taken into consideration.

  6. To "Anonymous said…,"climbing a wall of worry -S&P; 500: Now More than 20% Above Its 200 Day Moving Average-First time in 25years.

    Time to consider protection? How about buying call options on SDS or DXD with a strike out to jan10?

    First, I didn't calculate the percentage the S&P; has been above its 200 Day Moving Average, but the S&P; was above the 200 Day Moving Average almost all the time, from August 2006 to mid November 2007. My charts don't go back any further than March of 2006. It looks to me like the S&P; was above the 200 Day Moving Average 25%, or close to it, several stretches of that time.

    Second, just because the S&P; is 25% above its 200 Day Moving Average doesn't mean that it's not going to go higher (although it certainly could go lower). What technical analysis do you have that indicate the S&P; is going to go significantly lower? I don't see them, although technical analysis can be wrong, but there were a lot of technical analysis tools (Bollinger Bands, Stochastics, Parabolic SAR, 10 – 30 SMA) that showed the S&P; was going to drop, as early as June 2008, and they were correct.

    Lastly, as far as buying call options on the ETFs SDS (inverse based on the S&P;) and/or DXD (inverse based on the Dow), which would expire the third Friday of January 2010, I, myself, would not do that (But I am not a broker or a financial advisor, so anything I write is not investment advice; it is just what I personally would not do.) There are very few options with open interest greater than 100 on either one of these ETFs(I don't buy or sell an option with open interest less than 100, because, for me, I have found it is too hard to sell it or buy it back with fewer than 100 open interest.) for In The Money call options. I also like a Delta (the theoretical way an option increases or decreases in value as the underlying stock increases or decreases in value) of .70 or so, but not much lower.

    For a SDS January call option, I could only find one In-The-Money (Explaining In-The-Money, At-The-Money, and Out-Of-The-Money would take too much space; I almost always go with In-The-Money, because I have found, for me, it has the best chance of making me money.) call option, which had an open interest greater than 100 and a Delta close to .70 — it was .69. It looked to me like a buyer would pay from $590 to $630, today, for each one of those options.

    For a DXD January In-The-Money call option, it looks like, today, the only In-The-Money option with over 100 open interest would pay from $340 to $380 for each one of those options. But its Delta was .57. So, theoretically, if DXD moves up one dollar the option would move 57 cents. I don't like that kind of movement. For me, it’s not enough movement.

    So, for a lot of reasons, I, personally, would not do what you would do for protection. What you call protection sounds like high risk, to me. However, again, I am not a broker or financial advisor; I am just writing what I, personally would do. What I write is not intended to be financial advice to anyone.

    Instead of what you are thinking about doing for protection, I, personally, use stop loss, for options, which is very similar to what Ulli advocates — just with different numbers, mainly different numbers for the options — and I have stop losses on both the options and the underlying stock to which the options are tied, even though I have not bought the stock. So, if either the option, which I have bought or sold, goes the wrong way for me, I get out, by using a stop loss.

  7. Ulli,

    Isn't there a rule about selling a stock/fund/etf at a loss and then buying it back right after? I thought there was like a 30 day waiting period. You can buy a similar stock/fund/etf, just not the same one.

    Please correct me if I am wrong.

    Thanks,

    Dan

  8. 'Sell stop' is an excellent vehicle to hedge your portfolio of equities. But what about 'Mutual funds'? How can we use strategy like 'Sell stop' with mutal funds??

    MD

  9. Trailing stops entered with TD Ameritrade are predicated on the BID price .I have found this is a gift to the market maker who can manipulate his "book", legally most likely, to clear your order at below market price. I would never use a trailing stop for a stock with low volume. Even a stop loss is dangerous for low volume stocks. based on the past year and current "fast trade" nonsense I have far less faith in the integrity of our markets. They are turning into a casino.

  10. To: Dan, about you selling and buying back question. I believe you are referring to what is called a "Wash Sale". To my knowledge it doesn't have any affect on IRA type accounts, but only on personal taxable accounts. If someone else knows if this rule applies to IRAs and how it would affect them please respond on this blog.

  11. vermcj,one reason I picked jan10 was for lower cost option and went out to 60 calls for SDS. There is good open interest.
    60.00 SDSAH.X 1.25 0.00 1.10 1.20 42 9,146
    Don't forget you don't have to hit a strike and I expect good movement before/if it gets to 60.

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