In response to a recent post, reader Don provided this feedback a week ago:

This is in response to “How High Can We Go“, and the current overbought condition of the market. John Hussman has a superb article on this, which you can read here.

In terms of how to deal with the current market, instead of just making sure that one has stops in place because it’s likely that the market’s going to roll over soon, I think one should have stops in place all the time–including, and perhaps especially–in those markets in which it appears least likely that they’re going to roll over.

[My emphasis]

Yes indeed, the article by John Hussman is a worthwhile read.

Take a look at the highlighted sentence again. I want to make sure that there is no misunderstanding. Whenever you initiate any position (other than money market), you need to track your trailing sell stops no matter what the appearance of market behavior tells you.

Reader Don seems to imply that he does not have stops in place for those holdings that don’t appear likely to roll over, as he puts it.

That is not correct. If you are working with sell stops, the rule simply is to “track sell stops for all positions all of the time.” Never get caught without one, because you don’t know when and where the next shoe will drop.

Most investors don’t realize that market returns, as measured by the S&P; 500, are in negative territory for this decade.

In other words, even money under your mattress would have done better than having been invested on a buy and hold basis in the major indexes.

MarketWatch featured a story on the subject a month ago, but it is still as valid as it was then, especially with the markets having been in correction mode recently. Take a look at some highlights of “To finish the decade in the black, S&P; has its work cut out:”

After back-to-back 15% gains that made for the best two quarters since the first half of 1975, the S&P; 500 Index needs to advance another 39% for the index to break even for the decade.

Among the S&P;’s 10 industry groups, energy advanced the most from Dec. 31, 1999, through Sept. 30, 2009, with the sector climbing more than 92% and in need of a 48% drop to finish the decade at neutral. Conversely, telecommunications fell more than 66% during the not-yet-finished decade, with the sector in need of a 198% boost in the final three months to break even.

Sure, the market rebound of 2009 has been impressive by any measure, but for the S&P; to gain an additional 39% in the next 2 months is highly unlikely. It only took two bear markets in 10 years to destroy portfolio returns, which supports my view that is far more important to avoid the big drops in the market than to be permanently invested in the “best” funds.

With the recent pullback, even the odds of the S&P; reaching the level of our sell signal on 6/3/08 (1,318) are remote at best. As of Friday, the S&P; (1,036) would have to gain over 27% just to get back to that break even point.

Chances are pretty good that, given the general state of the economy, the next decade will bring more of the same.

Personally, I believe that we will see more stunning rallies, as the economy allegedly improves, only to be followed by jaw dropping pullbacks as reality proves otherwise. In other words, recoveries based on the “WW” concept (up-down-up-down) are very likely in my opinion. As a result, those investors simply buying and holding will again be left holding an empty bag.

Follow the trends unemotionally, get in when the markets confirm upward momentum, and get out when your trailing sell stops tell you to do so. This will be your best opportunity to deal with the ever increasing uncertainties in the market place.

With the market having sold off sharply last Wednesday, several sell stops were triggered causing reader feedback.

Here’s one comment, which came in Thursday morning as a rebound was underway:

EWZ has a big rebound from yesterday’s sell signal to this morning’s 6+% rise. I’m going to hold on to that one. Do you ever change your mind (from strict sell stop discipline) on any like that?

Absolutely! This is one more reason why I don’t ever enter sell stops ahead of time. You have to use some common sense or subjective reasoning, as I like to call it, before putting in your sell orders.

I touched on this before, but here’s my process again. After the close of the market on Wednesday, several sell stop points had been reached requiring action the next day. I prepared my sell orders and watched the market opening on Thursday. A rebound was in the making, and the major indexes already had moved up some 0.75% so I held off placing any orders.

As the morning progressed, and the main news of a positive GDP supported accelerating upward momentum, I decided that the odds of a higher close were pretty good.

As a result, none of my planned sell stops were entered. Only time will tell, whether this was a wise decision or not and if indeed this holding back prevented a whip-saw signal.

On the other hand, Thursday’s rebound could have been a one-day event, with the markets subsequently trending lower stopping me out a day or two later anyway. So be it. You have to realize that the use sell stops is not an exact science and probably imperfect in many ways.

Still, you need to use them as best as you can, because there is no other way I know of to successfully circumvent severe directional market downturns.

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

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

The bears spanked the bulls this week as poor economic reports pulled the major indexes lower.

Our Trend Tracking Index (TTI) for domestic funds/ETFs has now crossed its trend line (red) to the upside by +6.63% 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 +10.97%. 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 markets continued to stumble yesterday as downward momentum accelerated. Much has been written about a potential market top and one of the more interesting observations and references was made by Mish at Global Economic Trends in a post titled “Multi-year Stock Market Top could Be In.”

With yesterday’s action, several sell stops were triggered, and the affected holdings will be liquidated today. The position of the Trend Tracking Indexes (TTIs) relative to their long-term trend lines is as follows:

Domestic TTI: +7.14%
International TTI: +11.18%
Hedge TTI: +0.54%

Over the past month, continued reader feedback regarding sell stops was a topic of great interest. A few days ago, reader Bob had this to say:

Market is getting a bit testy right now. I noticed that my holding in Russell 2000 ETF is down 5.69% from its high today.

Another though I had was to use a stop of 8.5% (7% x 1.19) to account for its increased volatility. In fact I am considering doing this for all of my holdings. It is easy to do & follow with spreadsheet I have set up. I would probably round all exit calculations to the nearest 0.5% (as I did above) to make it easier to follow in the sell zone.

While that is a different way of applying the sell discipline, it does not really matter. My preference is to use the 7% rule for all domestic and international funds and 10% for the more volatile country and sector fund arenas.

You should use whatever approach you are most comfortable with. In the bigger scheme of things, using any type of sell stop discipline is better than using none at all.

Remaining exposed to the whims of the market place with no clear exit plan has proven to be disastrous in the past and may very well be the downfall for many investors again in the future.

As the markets begin to show signs of weakness, questions about the sell stops keep coming in. Here’s one from a reader asking for clarification:

You also suggest selling a fund if it has dropped more than 7%from its most recent high. My question is, if a most recent high occurred in May this year and the fund/ETF is down more than 7% now since May, do you still consider it a sell? What if it was bought since May (maybe shouldn’t have)?

It’s not the recent high, or the high since May, that a fund/ETF has made that’s important. It’s the high that was made since you bought it that counts.

When using a trailing stop loss, which will limit your losses and/or lock in your gains, only the price action, which occurred after your purchase is of any relevance. To be clear, what a fund/ETF has done in the past in terms of price movement maybe a consideration in your selection process, but has nothing to do with the execution of the sell stop discipline.

Once you have made the purchase, only then will the tracking of the closing prices going forward form the basis for your exit points—not before.