In “Missing the Point” I talked about the purpose of using sell stops, which is to limit downside risk and not to initiate a short position as one investor intended to do. I also said the following:

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.

Reader Jon posted the below comment in response:

A great reminder about stop-losses. I am not sure I entirely agree with you that selling at the trend line will “very likely turn any accumulated profit into losses”. If you buy only when the index cuts above the trend line and sell when it cuts below it you will, by definition, realize profits equal to the increase in the trend line between these two moments in time!

You are absolutely correct, if you buy and sell exactly at these two points. However, reality is that investors move into the market even after a buy signal has been generated to try to take advantage of upward momentum. Or, new clients come aboard in my advisor practice during mid-cycle and need to have their assets deployed.

That’s where you obviously enter not at an optimal point in time, which is the reason to have sell stops in place to guard against the downside risk.

Another scenario that can cause issues is if you have a sharp rally, after a buy signal has been generated, which is followed by a sharp decline within say less than 3 months, your trend line will have moved up only by a small percentage.

If you happen to have invested in a sharply rising fund/ETF, which now follows the market reversal back down just as quickly, you may witness a 20% gain turn into a 2% profit as the trend line gets crossed to the downside. That’s were implementing a 7% sell stop has its advantages, since it would have locked in a gain of some 13%.

In any event, Jon’s point is well taken; just be aware that there is no perfect solution.

The ultimate goal is to avoid the big disasters like 2001 and 2008 even if you whipsaw a few times along the path. If you can just do that, you will be outperforming over 90% of all money managers and mutual funds.

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

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

Slow and steady was the name of the game as the major indexes gained moderately.

Our Trend Tracking Index (TTI) for domestic funds/ETFs has moved above its trend line (red) by +5.12% (last week +5.89%) and remains in bullish mode.



The international index has broken above its long-term trend line by +7.02% (last week +6.93%). A new Buy signal was triggered effective 9/7/10. If you decided to participate, be sure to use my recommended sell stop discipline.

[chart courtesy of marketwatch.com]

It wasn’t pretty yesterday, but the markets managed to sputter higher in the face of rising interest rates and a subsequent higher dollar.

The bond selloff was a clear result of politicians having favored the Bush tax cuts over spending cuts. While in my view the extension of lower taxes in itself is a good thing, with nothing but red ink in sight, the bond market saw things differently and higher rates caused prices to pull back.

The dollar rally pulled gold off its lofty levels, joined by silver, while copper bucked the trend under the assumption that the tax cut extension may produce more economic growth.

The market’s still look like they are going through a consolidation phase, which may form the base for the next leg up. Again, a new driver is needed to push the major averages to the next level.

As I posted Monday, this is the time to watch for yearend distributions in your holdings; be sure to adjust the high prices downward to be in tune with the correct trailing sell stop points.

After briefly hitting a 2-year high yesterday, the S&P; 500 lost upward momentum, slipped, recovered but faded into the close ending up nearly unchanged. During the trading day, I was observing some intra-day charts, and the activity was painfully slow; it reminded me of watching grass grow.

Nevertheless, it appeared to be a consolidation day, which is a normal occurrence after the sharp upturn we saw last week.

The initial sprint was a result of President Obama agreeing to extend the Bush era tax cuts while reducing worker payroll taxes and agreeing to continuous jobless benefits for the long-term unemployed.

The dollar ended up higher along with interest rates, while gold and crude oil slumped. No earth shattering news from Europe made this a fairly calm trading day.

None of our sell stops were triggered, and it remains to be seen if the S&P; 500 can generate enough strength to break through yesterday’s high again.

The markets were not able to gain much traction yesterday as the major indexes meandered without much conviction and ended up closing around the unchanged line.

Investors were still trying to digest Fed chairman Bernanke’s relatively gloomy outlook, which he presented on CBS’s “60 Minutes.” Just the fact that he sees unemployment hovering near record levels for some four to five years took the starch out of any upward momentum.

Additionally, he is entertaining the possibility of more quantitative easing depending on the economy’s reaction to the current efforts. All in all, it represented a pretty somber view as the economy struggles to rebound.

Gold again was the beneficiary of this uncertainty, and promptly hit a new high in the most actively tradedFebruary futures contract. Commodity prices rose as did energy and material stocks.

Eurozone worries remained on the front page news menu as the EU ministers were meeting to decide whether the current rescue package will be sufficient in size. As a result, the Euro slipped and the dollar gained, which may have played a part in keeping a lid on equity prices.

This is the time of the year when mutual funds and ETFs declare their annual distributions.

If you are tracking the sell stops for your positions, it’s imperative that you adjust the “high” numbers.

For example, let’s say that you bought an ETF/mutual fund earlier this year or last, and it reached a high price of $10 since you bought it. This high price becomes the basis from which you calculate your 7% trailing stop loss point.

Let’s say a distribution of $0.25 is declared. Since any distribution reduces the price of the security by the same amount, you will also need to adjust your high price down to $9.75. If you don’t, you will be getting an incorrect signal when your sell stop gets triggered.

In this example, the distribution of $0.25 equaled 2.5% of the current price. If you don’t adjust, you will be suddenly working with a 4.5% trailing sell stop instead of my recommended, or your intended, 7%.

As an aside, many brokerages also don’t account for distributions right away in their YTD performance figures. Simply being aware of that will avoid you having “sticker shock” when suddenly your returns are showing a much smaller number than you’ve seen before the distribution occurred.