Reader GH had an interesting comment about the effectiveness of sell stops:

I’m afraid that the sell-stop methodology is going to become a problem for investors.

Your retirement will depend mostly on your savings, not how much you can make on your savings. Wall Street has it figured before you ever get the chance to sell-stop.

While I agree with your statement that your retirement should depend mainly on your savings, and only secondary on the gains you make from your investments, I don’t believe that the use of sell stops will increase the incidents of churning.

Having said that, I have also repeatedly warned against placing sell stops ahead of time (for ETFs), since front running can create this kind of unintended churning as your sell stops are a known fact. I’ve talked about that in “Front Runners” a couple of weeks ago.

However, if you, as I recommend, base your trailing sell stop points on day-end closing prices for ETFs as well, and only enter the order the following day after your stop has been triggered, you will eliminate advance knowledge of your intentions.

Sure, as is the case with all investment methods and approaches, nothing is perfect and neither are sell stops. However, in my book it’s the best thing you can do to protect yourself from portfolio disaster.

Looking back, I did not get the impression that any churning was involved last year, nor did I feel in any way taken advantage of, when we liquidated millions of dollars of positions leading up to our final sell date of 6/23/08.

With ETFs being the investment choice for many investors and advisors alike, it should come as no surprise that the Mutual Fund Universe is shrinking amid bear market hangover:

Call it survival of the fittest, or a thinning of the herd.

Through early this month, almost 500 funds had disappeared, according to investment research firm Morningstar. That’s about twice the total of new funds started this year. The last time closures outnumbered launches was 2002, when the bursting of the dot-com bubble compelled the fund industry to downsize.

The story goes on as to what to do and what to look if you get a mutual fund liquidation notice. If that has happened to you, be sure to read the entire link.

While having a variety of investment choices is always a good thing, 8,000 mutual funds are way too many, especially in view of the fact that ETFs are picking up the slack. Even in the relatively small ETF world, some have already disappeared due to lack of interest (volume) and redundancy.

The shrinking universe has not only affected newcomers but also funds that have been around since the 80s and early 90s, and have had a wide following. Poor management and possibly restrictive trading policies could have added to their demise.

I was affected indirectly as one fund, which had been a part of my international Trend Tracking Index (TTI) since 1994, just closed shop. The fund, which shall remain nameless, was replaced and the TTI updated accordingly.

This happens every so often and does not affect the continuity or accuracy of any of the TTIs.

One reader had this question about the use of sell stops:

I already own some funds where the most recent high was about 30 days ago and the funds have come down about 2.5 to 4%. If I want to use the 7% trailing stop rule, do I simply take 7% of the high 30 days ago and set that as the stop?

And if I buy a fund now, do I still use the most recent high from 30 days ago or just from the price I just purchased the fund? Thank you for you newsletter and blog.

The base price from which you measure your sell stops is in fact the highest price this fund has reached since you bought it. In your first example, that would be the price from 30 days ago.

However, if you decide to purchase more of this fund now at a lower price, you start all over in terms of finding a new high price for this portion of your holdings. For example, if you buy this fund now at $10 and the price subsequently ends up moving something like 9.90, 10.05, 10.20, 10.40, 10.30, 10.15, etc., then 10.40 would be your new high price to be used as a base for figuring your 7% sell stop (until it is replaced by a new high, of course).

I have never come across this situation, since my preference is to add more positions on the way up, when momentum is in my favor, and not on the way down, when a trend reversal could be in the making. This keeps the same high price high price intact for old and new positions.

Occasionally, I have written about the lack of investment choices in 401k plans.

While I manage a number of these, most are with Fidelity and have a wide variety of fund selections although many still have no access to ETFs.

Even though ETFs are all the rage, are you really disadvantaged by not having them available?

To offer a different viewpoint, let me share with you this experience about a client who works for a Fortune 500 company.

When I first took over his 401k account 5 years ago, I was simply flabbergasted when I saw the investment choices. Given the type of company he was employed by, I expected to see, well, a wide variety fund selection covering all of the major markets.

When I logged on to his account, I was downright shocked. The entire 401k plan consisted of the following:

1. Short-Term Fixed Income Fund
2. Growth Equity Fund
3. International Stock Fund
4. The Company’s own common stock

That was it. Additionally, the growth and international selections were not modeled after some well-known mutual fund, but unidentifiable as far as looking at long-term historical trends was concerned.

To me, this was about as skinny as you can get when it comes to fund choices.

Here’s the surprising outcome.

When our international TTI signaled a Buy on 5/11/09, I decided to use my incremental buying procedure by allocating 1/3 of this portfolio to the International Stock Fund. The fund rallied nicely and, 3 weeks later, it had gained over 5%, so I allocated another 1/3 increment. Subsequently, the domestic TTI signaled a Buy and I invested the remaining 1/3 into the Growth Equity Fund on 6/3/09.

The markets bobbed and weaved, especially in July, but the international fund holding never pulled off its high enough to generate a whip-saw signal. Neither did the Growth Equity fund.

As a result, this portfolio has grown over 20% (for the period 5/11/09-11/13/09), matching the S&P; 500, despite the incremental buying process. While the sell stops were in place at all times, we only got as close as -5% at one point.

Here’s a portfolio that had nothing going in terms of investment options, yet it outperformed (much to my chagrin) all others, which had more investment choices in mutual funds, ETFs, sectors and countries.

This is clearly a case when less can be more, certainly in terms of results. It underscores the point I have made before that less volatile funds/ETFs have advantages when used with trend tracking, because they tend to avoid whip-saw signals.

With the intention of the investment world not only being focused on ETFs but also on providing a mind numbing number of choices, it may behoove some investors to review the sometimes casino like behavior that this can promote.

Scale back on volatility and look for a few steady performers because, as in this case, slow and steady has a good chance of winning the race.

Reader VR posted these comments:

I understand there are two ways you can get whip-sawed. One is the big bang event in which the trend line crosses from buy-to-sell-to-buy.

In other words, is it better to just follow the trend line?

The short and incomplete answer would be: It depends on market behavior.

If you have a slow and steady uptrend, with the Trend Tracking Indexes (TTIs) remaining fairly close to their trend lines, then you could use the trend line as your exit point. Actually, that’s what I have done throughout the late 80, 90s and into the year 2000.

Things changed when the tech bubble burst and the markets not only crashed but also whip-sawed several times during the first nine months of 2000. Take a look at a chart of the domestic TTI for that period:



The large red arrows on the left show the highs and lows the domestic TTI made during the blow-off period. It is obvious that, if you had followed the piercing of the trend line as a signal to sell, you would have given back most of your accumulated profits since the Buy of 11/17/1999.

That is the inherent problem. Whether you use the TTIs as I do, or simple 200-day moving averages for individual funds/ETFs, the issue remains the same.

A strong bullish period will drive the price line (green) way above trend line (red). If this happens within a short period of time (6 months or less), the trend line lags too much to lock in any profits in the event of a trend reversal. While you may avoid an above the trend line whip-saw here and there, you also risk giving back most of your gains.

That creates an emotional problem for investors as well when seeing accumulated profits evaporate by waiting for the trend line piercing to generate the sell. I have seen, during violent moves such as the above chart shows, unrealized gains of 40% evaporate down to 3%. While you personally maybe be able to handle that, if you manage money for others, that is simply not acceptable.

The bottom line is that I have found the use of a trailing sell stop, when above the trend line, a far better choice in controlling risk (locking in profits and limiting losses), especially in the volatile environment we are living in.

My latest No Load Fund/ETF Tracker has been posted at:

http://www.successful-investment.com/newsletter-archive.php

Continued bullishness has the S&P; 500 knocking on its 1,100 level.

Our Trend Tracking Index (TTI) for domestic funds/ETFs has now crossed its trend line (red) to the upside by +8.45% keeping the current buy signal intact. The effective date was June 3, 2009.



The international index has now broken above its long-term trend line by +13.21%. A Buy signal was triggered effective May 11, 2009. We are holding our positions subject to a trailing stop loss.



[Click on charts to enlarge]

For more details, and the latest market commentary, as well as the updated No load Fund/ETF StatSheet, please see the above link.