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.

The explosion that rocked Wall Street last week was bond guru Bill Gross’s (PIMCO) admission that he has turned bearish and that worldwide stronger economic growth over the next few years will lead to higher interest rates.

Bond prices tanked, yields rose and real estate funds/ETFs headed south. Some media had a hard time comprehending why Mr. Gross changed his position after having been a long-term bond bull. Did he cave in?

Not in my view. PIMCO is in the investment business and fundamentals, even for those with a very long-term view, change from time to time. I like the quote from famous economist John Maynard Keynes best who said, when encountering criticism about his change in viewpoint, that “when the facts change, I change my mind—what do you do, sir?”

What are some of the effects of higher rates? A good analysis to read is Michael Shedlock’s story on “The Bond King’s Capitulation.”

Of course, the trend to higher rates will be a severe handicap for the Fed in potentially bailing out the most troublesome weak spots in the economy, namely SubPrime and Real Estate.

Whenever the market behaves in a tumultuous way to the downside, as it did last week, I like to look back to see if there were any mutual funds or ETFs that bucked the trend. I’m not talking about the obvious bear market funds, but others that may have held up well and may have been part of your portfolio.

This is only a short-term view of market activity and certainly not meant for you to rush out and buy those that survived the week on a positive note. But you may consider them and do further research to see if an investment in them is merited.

Higher interest rates were the culprit for last week’s 3-day slide, which means that interest rate sensitive funds/ETS fared the worst. This is confirmed in our momentum tables; here are the worst of the bunch out of my data base containing 1,504 funds/ETFs:

1. UTPIX, Utilities, -7.80%
2. PMPIX, Precious Metals, -7.05%
3. XLU, Utilities, -5.30
4. EWZ, Latin America, -5.28%
5. FSUTX, Utilities, -5.27%

The top five, which held up best, are:

1. CH, Country Fund, +3.04%
2. TIFQX, Technology, +2.75%
3. TF, Pacific Asia, +1.44
4. EWT, Pacific Asia, +1.22%
5. CNZLX, Pacific Asia, +1.17%

As a general comparison, the S&P; 500 lost -1.87% for the week while Gold dropped -3.38%. That means that even a traditional safe haven such as Gold failed to hold up again just like it failed during the meltdown of February 27.

While it is important to diversify your holdings, it is not a guarantee that your portfolio will withstand a severe market slide. The sell offs during May/June 06, at the end of February 07 and now last week, are proof that many markets work very much in tandem and to own a “zig” holding when the market “zags” is rare indeed.

That’s why I continue to believe that a clearly defined entry and exit discipline is the best way to deal with market uncertainties and keep your portfolio from freefalling.