Seeking Alpha featured an interesting piece called “How Traders Are Front-Running ETFs:”

Another aspect of exchange-traded funds (ETFs) coming to the fore lately is front-running. That’s the practice where traders buy ahead of large orders from ETFs and short sell ahead of large sell orders. They scalp profits by flipping their newly acquired long positions back to the ETF at higher prices and closing their short position at lower prices. The ETF ends up paying more to buy securities and receiving less to sell; in effect, traders have transferred profits from the ETF to themselves.

But the story changes as one departs from plain vanilla, broad-based ETFs. Of note, the more markets are sliced and diced into smaller slivers for ETFs to track, the more likely index changes will become significant in relation to the index basket. And, in turn, so does the opportunity for front-runners to transfer returns from ETF holders to themselves.

This is one of the reasons why I never place sell stops ahead of time as “stop orders.” I don’t want to get stopped out because of alleged front running activities or simply other intraday market noise.

I suggest you do the same by using “day-ending closing prices” only to see if any sell stop has been triggered. If it has, only then do I enter my order the next day.

This avoids intra-day whip-saw signals and simplifies my tracking. In other words, I treat ETFs like mutual funds in that, for sell stop purposes, only one price per day exists.

Due to my travels back from Germany, there will be no post today. Regular posting will resume on Tuesday.

Despite the market’s sharp rebound off the March lows, I have questioned the fundamental reasons on which this alleged economic recovery was based.

To me, it was nothing but government stimulus along with wishful thinking that supported this move into the stratosphere. What happens when the stimulus ends?

My concern has always been that a recovery, such as we’ve seen, can never have staying power unless it is accompanied by job growth. While job growth is considered to be a lagging indicator, I simply can’t see any job creation because of rampant overcapacity in most industries.

One hedge fund manager has similar concerns in “Hedge manager Sprott sees trouble when easing ends:”

When so-called quantitative easing by central banks ends, the world economy may slip back into trouble, Canadian hedge fund manager Eric Sprott warned on Tuesday.

Banks leveraged roughly 20 to 1, have about 5% of equity supporting mostly paper assets. If those assets fall by more than 5%, the institutions are effectively bankrupt, Sprott said.

I agree with his assessment. While there is nothing about the potential outcome you and I can do, it helps to be aware of the likely consequences, even though we may be entering un-chartered territory.

I believe the market at current levels has more limited upside potential, but poses tremendous downside risks. Again, as trend followers, we don’t predict or worry about which way the trend will turn.

If continued government stimulus occurs, we will most likely run with the bulls. If not, and the trend reverses favoring the bears, we will let our trailing sell stops guide us as to when to exit.

While I am singing the same old tune, I believe it’s crucial to have a plan in place so you don’t end up like the buy-and-hold crowd, because they’re doomed to repeat the mistakes of 2008 again.

If you look at the chart of the domestic Trend Tracking Index (TTI), it’s obvious that the market has rallied since March without regards to the laws of gravity—so far.

The million dollar question is “how high can we go?” Every investor expects a serious pullback, but so far it has not happened. Maybe the chart of the TTI can give us some clue as to where a (temporary) top may occur.

When the markets headed south last year, and entered freefall mode, 2 gaps were created on the domestic TTI (see red arrows) price chart. Since they occurred to the downside, they are called exhaustion gaps, meaning that selling activity far outpaced buying activity.

Chart technicians will tell you that gaps will always be closed. In this case, that would translate to prices moving to a point that is higher than the beginning of the gap opening. The lower gap (lower red arrow) has been closed already, and we’re now half way (44.00 price level) through closing the upper gap. This process would be completed at around 44.50.

Having looked at thousands of charts over the past 20 years, this pattern occurs with regularity, the big unknown is always the timing of it. Just because the exhaustion gaps occurred last year does not mean they will be closed this year. However, we seem to be on track with the TTI only having to move up another 1.14% from the 44.00 level.

Here’s the rub. Once the closing of the gap occurs, odds are high that the trend will reverse. However, as anything that has to do with investment concepts, nothing is 100%.

This is not a prediction on my part; it’s simply a pattern that I look at from time to time to try to get some sense as to how high we could go. So, let’s watch out for the 44.50 level.

If this nugget of wisdom does not play out, there is a good chance that still higher prices are ahead.

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

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

Whip-saw moves left the major averages with slight losses for the week.

Our Trend Tracking Index (TTI) for domestic funds/ETFs has now crossed its trend line (red) to the upside by +8.53% 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 +14.90%. 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.

Recently, reader Vermcj had some interesting comments regarding sell stops and his experiences. In case you missed it, here’s what he said:

So, I stick with closing prices as the best way, for me, to determine when my sell stops has been hit, even though I don’t know of any computer program or brokerage firm+ that will calculate closing prices as daily sell stops.

I believe that poor choices in stocks, ETFs, mutual funds, futures, and options are more forgiving than ignoring stop sells.

[My emphasis]

I agree. It’s important that you track your sell stops on a daily basis, especially if the market heads higher so that you can capture the new high price of your holdings. This new high price will form the basis for calculating the 7% trailing stop loss. On minor pullbacks, you can check price action, but there will be nothing else to do.

If you set up your tracking on a spreadsheet, this should take no more than a few minutes a day.

Look at the highlighted sentence above. I agree wholeheartedly that a poor selection of funds/ETFs is more forgiving than ignoring sell stops. The reason is obvious: A poorly selected fund may turn out to be a lagging performer, while not paying attention to sell stops can ruin years of investing.

That’s the lesson of 2008. Unfortunately, millions of investors had to learn this fact the hard way.