Missing The Point

Recently, a reader emailed and wanted to know if it was a good idea to go short the market after his 7% trailing sell stop had taken him out of a position.

While the short answer is clearly no, I want to elaborate on that issue. The trailing sell stops fulfill the purpose of controlling the downside risk of your holdings. Sure, you may get lucky, short the market, which subsequently declines, breaks through our long term trend line and changes market direction from bullish to bearish with you riding the trend all the way down.

While that is an ideal scenario, the chances of it happening are slim. More often than not the markets will fluctuate, reverse and head back up after you get stopped out, at which point you are looking for a new entry point as you’ve just experienced a whipsaw signal.

Sell stops are simply a safety measure to guard your portfolio not only from sharp setbacks but, as importantly, protect you from sliding down a bear market slope with long positions intact.

The time to consider a short position is when the prices of our Trend Tracking Indexes (TTIs) actually cross their respective trend lines to the downside. That would be the proverbial line in the sand, which divides bullish from bearish territory.

If you are a very aggressive investor, you could work without sell stops and only use the crossing of the trend lines as your last line of defense to cash out and head for the sidelines. However, be aware that, depending on the current positions of the TTIs, it can be a long way down, and you will very likely turn any accumulated profits into losses in the process.

Use the sell stops only for the purpose they were intended and not as a sign that market direction has moved from bullish to bearish. Only the TTIs can make that determination, since their signals represent major directional changes and not minor ones.