The recent roller coaster ride in the stock market was caused by a variety of events, one of them which was a rise in interest rates.

If you held any income producing bonds, bond funds or municipal closed end funds, you undoubtedly have seen the values head south as they always do when rates are rising. Personally, I have watched the tax-free income portion of my portfolio go from about +1.50% to -3.00%.

This is a normal occurrence within an economic cycle, and you need to look at the income generating process with the right frame of mind. If you invest for income, and your funds/ETFs/CEFs pay monthly dividends, then that’s what you need to focus on. After all, the income is what will support your lifestyle and not the value of your portfolio.

Interest rates will always fluctuate and, in times of lower rates, you’ll have some potential for capital gains, while, during times of higher rates, you may see the value of your portfolio head south. Whether rates rise or fall has no effect on the underlying issuer to pay your monthly dividends, so don’t get too emotional about it.

Here’s another way to look at it. I have a friend who prefers generating monthly income from his real estate holdings. He owns several single family rental homes, which provide him with regular monthly income that he collects from his tenants.

In his area, real estate prices have come down some 20% off their highs. Translated, that means that the value of his real estate income portfolio has gone down by several hundred thousand dollars. I asked him if he was worried about that kind of price drop but his response was that he was living well off the generated income and that the value only mattered if he were to sell.

Obviously, even if he wanted to, he couldn’t just turned around and liquidate his real estate holdings overnight as you can with a bond fund. However, maybe there is lesson to be learned here, which is to focus on the purpose of your investment. If it does what it was designed to do, why worry about things that are beyond your control anyway?

However, I believe that no matter what you invest in, there should be some kind of ultimate safety net, in case the world goes haywire. Just like using the Trend Tracking Index (TTI) for growth investments, I will draw a line in the sand when I will sell my income portion. After all, I am old enough to remember 21% mortgage rates and 16% money market interest in the early 1980s.

While we may never experience that again (hopefully), my line in the sand for my income portfolio is a drop of -7%—just in case.

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

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

The bulls took over and all major indexes gained solidly for the week.

Our Trend Tracking Index (TTI) for domestic funds/ETFs is now positioned +4.52% above its long-term trend line (red) as the chart below shows:

The international index has now moved to +8.94% above its own trend line, as you can see below:

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

With the markets displaying some roller coaster similarities, this is as good a time as any to look at the process I go through in the event one of my sell stops gets triggered.

Also, how I might deal with the inevitable fact that, sooner or later, the TTI (Trend Tracking Index) will slice through its long-term trend line to the downside, thereby generating an all-out Sell for all domestic equity funds/ETFs.

Reader Nitin sent in the following question, which made me realize that my sell stop discipline is a little more than cold and hard percentages. Here’s what he had to say:

“Ulli: I read the update on your blog after the market activity of June 12. Overall, I agree with your approach to investing and tracking the market activity by some objective parameters to prevent getting run over by the bear market.

For example, is it possible that in a dynamic process of market activity what worked in 2000 may not be applicable in 2007 or 2008? This is not a criticism about the current approach. I am just raising a caution about being too precise about the numbers.”

That is great feedback and allows me to be a little more specific about the process.

The key point about trend tracking is that you have to draw a line in the sand somewhere where you need to take a stance. In other words, at some point, action is required to both lock in some profits and avoid having your portfolio go down in a bear market.

You are absolutely correct that this is not an exact science, but not getting emotionally involved in the decision making process is crucial. Otherwise, there will always be reasons why “it’s different this time,” which is one of the big portfolio killers. It’s never different this time!

However, once we reach critical mass, meaning when either the 7% sell stop point is triggered or the TTI has crossed its long-term trend line, I do apply some wisdom gained from 20 years of experience in the trenches. Realizing that the possibility of a whip-saw always exists, I try to show a little flexibility.

Here’s how:

If one of our fund holdings drops below the pre-set sell stop, I don’t immediately place a sell order. I watch the next day market opening to see if prices are rebounding or are further sinking. If it is a neutral scenario, I may wait a couple of days for confirmation that we are actually heading further south before entering my sell order.

The same applies when the TTI drops below its long-term trend line. Here too, I want to get confirmation of further downside movement before selling and heading to the sidelines. However, I will not try to outguess the trend that is clearly reflected in the numbers. It will backfire as I have witnessed with a large money management firm that has been using trend following for 30 years.

First, during the rebound in April 2003 (after the bear market), they “outguessed” the trend and missed one of the greatest rallies in recent years. Same thing happened last year, when a trend emerged again after the May/June meltdown, and this firm stayed on the sidelines and is now staring at a market that has been on an uptrend for 9 months.

My point is that investment discipline coupled with some applied experience will be the best guide in surviving a tumultuous market environment.

Reader and client Nitin pointed out an article in the NYT called “Is It Just A Strong Market, or The Bubble, Part 2?”

The story goes on to compare the differences between the events of 2000 and the market in 2007. Several academic studies suggest that current sentiment isn’t likely to be low enough to prevent another bubble form forming.

Professor Porter pointed out that a typical pattern for a burst bubble (2000) is to be followed by a somewhat less extreme version of the original—something he refers to as a “bubble echo.” He said that this pattern has appeared so consistently in psychological experiments that “you could almost set your clock according to it.”

There are some interesting points he makes, but he also admits that his research can’t be used to predict when a bubble echo might burst.

Too bad, I thought I had something of value here that could be used to somehow improve my investing prowess. I guess it’s back to tracking trends and monitoring sell stops.

Just a quick update as to how today’s downside activity has affected our Trend Tracking Indexes (TTIs).

Our domestic TTI has come off its high by 3%, but still remains above its long-term trend line by +2.39%. The international TTI also moved lower and currently sits +6.80% above its own long-term trend line.

None of our pre-set trailing sell stops have been triggered, although the Utilities sector seems to be closest to a potential ‘Sell’ by having come off its high by -8.59%. Keep in mind that for volatile sector and country funds/ETFs my sell stop is at -10%. For domestic and general international funds/ETFs my trigger point is at -7%.

I’ve touched on this before, but it’s worth repeating. With the onslaught on new ETFs coming on the market, it’s important that you don’t jump in before you get all of the facts. I generally make it a habit not to invest in any ETF, or mutual fund for that matter, if there is not at least some 9 months of price data available.

This will allow me to track the trend and also observe the daily volume. A recent article in the WSJ called “Before you drive that hot ETF…” details other points for you to consider:

1. Expenses
2. Trading Costs
3. Confusing choices
4. Aberrations from tracking an Index
5. Performance histories
6. Hedge Funds and high rollers

While not all points are critical, it pays to read the story to make sure that you are aware of some of the pitfalls you may have been unaware of.