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.

The use of sell stops and re-investing monies you have been stopped out of as the market resumes its upward trend, has been the hot topic of the past few weeks. Reader Paul had this to add:

A few questions regarding your tactics for reentering the market with “stopped out” money:

1. Typically, what kicks off your decision to start reentering the market?
2. Do you only enter into funds that have a 0.0 %DD?
3. Assuming the trend remains positive, do you give yourself a target deadline for reinvesting all of your “stopped out” money?

For one, a resumption of upward momentum will always make me realize that I have been whip-sawed and cause me to re-deploy the proceeds such as happened early this week.

Second, depending on your risk aversion, you could wait until the funds/ETFs, you’ve been stopped out of, take out their old highs before re-entering. Or, you could select different funds/ETFs along the lines as I profiled back in July in “Using The Benefit Of Hindsight.”

Third, I don’t give myself a deadline for re-investing stopped out money but, if I see a rally building early in the morning, such as we had last Monday, I try to get back in as quickly as I can.

Keep in mind that trying to find a new entry point is not an exact science. You never know for sure if you’re making the right move at the right time. The idea is to get back onboard quickly if the trend goes your way. This also means that you need to quickly accept the fact that the stop point may have turned into a whip-saw by not dwelling on it.

That’s the moment in time to look at the big picture and remember that you are using stop losses for a reason, which is to limit downside risk.

The WSJ featured an interesting viewpoint in “Are ETFs Causing an Emerging-Markets Bubble?” Here are a few highlights:

U.S. investors have pumped roughly $26 billion into emerging-markets funds so far this year. Of that, $15 billion came in through exchange-traded funds — portfolios that hold every stock in a market benchmark with utterly no regard to price.

So what does all this mean for investors? ETFs probably haven’t caused a bubble, and they might even help a bit to prevent one from forming. But many will remain superconcentrated bets on very risky markets. If you invest in an ETF with most of its assets in a few stocks and think you have made a diversified bet, the real bubble is the one between your own ears.

As a general rule, I don’t think bubbles in any market pop over night. Sure, you may have the occasional Black Swan event, but even during last year’s market crash, prices started to head lower at a slow pace at first and accelerated later on.

Take a look at the EEM chart above. For those with sell stops in place, the initial market pullback provided plenty of opportunity to liquidate any positions. Even if you gave yourself more room and sold as the price crossed the trend line to the downside, you would have had no problem getting out.

As always, the key here is not to worry about wild speculations as to what might or might not happen to this market but to be prepared to exit when the trends reverse.

That alertness to changing conditions, more than anything else, will save your portfolio from a receiving a severe haircut and will help you emotionally to better deal with a declining market.

Disclosure: We currently have no positions in EEM.

From the moment the markets opened yesterday, it was up, up and away with the Dow hitting a new high for 2009.

Friday’s unemployment figure of 10.2% contributed in a perverse way to yesterday’s rally supporting the view that with such dire news, interest rates will have to stay low for some time to come, which bodes well for stocks.

Additional market support came from the G-20 via an agreement over the past weekend to keep the stimulus programs going. That’s all that was needed, and the major averages never looked back.

I took the opportunity early on yesterday morning to add some new positions, in essence replacing those that we were stopped out of during the last pullback. Of course, all sell stop points have been identified and will be executed when necessary.

While the stamina the market has shown is simply amazing, I have to wonder how long it can last. Since no one has the answer, we will simply follow the trend until the end when it bends.

While ETFS have many advantages over mutual funds, they have not been around long enough to address all issues that might affect their NAVs as Seeking Alpha reports in “Bond ETFs Suffer from Pricing Discrepancies:”

Exchange traded funds (ETFs) have many of the built-in advantages that mutual funds have, but there are also differences. In my view, the biggest difference is not the fact that ETFs trade throughout the day or even how ETF pricing works, but rather that ETFs have a very short operating history.

This last point is a good one though. If all the investors in a given ETF want to get out at the same time, raising cash may be an issue. And, if a given ETF has to raise a lot of cash quickly, it will probably get dinged a bit on those securities that it sells.

[Emphasis added]

While there is no good way to deal with this pricing issue, you might want to consider no load mutual funds if your mode of operation is to generate income.

However, in a zero interest rate environment, the risk in bonds, bond ETFs and bond mutual funds is clearly to the downside, especially if inflation rears its ugly head somewhere down the line.

While there is no perfect solution to deal with this issue, I would never hold any of these funds/ETFs without the use of a trailing sell stop.

When the tide turns and interest rates rise, you want to be one of the first heading for the exit doors before they become too crowded. A trailing sell stop may just be the vehicle to get you there before the masses wake up and follow suit.