Stop Loss and M-Index Clarification

New reader Lloyd had this experience to share:

I invest in mutual funds and ETFs. I was using Fidelity funds and using the 1 mo, 3 months, and 1-year returns to pick the best performing funds.

This seemed to work okay, but recently it had me in all oil and oil related funds and when oil dropped I lost all my profits. I was wondering if your method would do the same or would it get me out with some profit. Also, what do you use for a sell signal for the sector ETFs and sector mutual funds?

I was looking at your M-Index and wondering why you use YTD in your calculations rather than 1 year. It seems to me that if you use YTD, you’re not always using the same number of months to make your calculations. The last month of the year the YTD is 12 months of data whereas the first of the month of the year the YTD is only one month. Does this affect the ranking?

First, using longer term momentum figures as Lloyd suggests can work as well. However, you still need to pay attention to the direction of the trends and follow a strict sell stop discipline. Just because momentum figures are still in positive territory does not mean holding a fund/ETF is advisable.

Once you have established your invested position, you need to set up your trailing stop loss point. For sector and country funds, I use 10% and for domestic and broadly diversified international funds I use 7%. Without it, you are exposing yourself to tremendous risk no matter which investment approach you use.

Second, you are correct in your observation that the value of the M-Index is reduced to a smaller number every January due to the new YTD returns. Since all M-Indexes for all ETFs/Mutual Funds are adjusted at the same time, it really does not really matter since the figure by itself has no meaning. It is only important when compared to others and shows increasing and decreasing momentum.

Again, when working with momentum figures or trends in general, the implementation of a sell stop discipline will save your portfolio from major damage. Unfortunately, many Buy & Hold investors have not figured that out yet and will have to learn the hard way (by losing serious money) that a bear market is not to be taken lightly.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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