Living With A Sell Stop

With the international markets having come off their highs, after racing out of the gate following our Buy signal on May 11, 2009, many readers have been stopped out of their positions and are looking for a new entry point.

Reader Dave had this to say:

I thoroughly enjoy reading your daily blog. I am convinced that your method is far superior to buy and hold but seem to have stumbled out of the gate and would appreciate some help in a couple of areas.

On the first day you gave the buy signal for international and domestic funds I purchased funds from your list. I recently hit my 7% stop loss for domestic and 10% for international funds for a loss. Please provide some comments on the following:

1. Should I pick additional funds and re-enter now or wait?
2. Any additional comments on which funds to pick would be appreciated.
3. Comments on how to set stop losses…7%, 10 %, etc.

I am 54, have suffered through the buy and hold of the early 2000s and 2008.

Dave brings up some good points that are worthy of further examination.

First, let me make it clear that, once a sell stop has been executed, you will find yourself in no-man’s-land. If the markets head further south, you’ll feel like a hero in that you made the right decision. If, on the other hand, the markets remain stable, or start to move back up, you may question the wisdom of your choice.

No matter what you do, you need to simply accept the fact that there is no perfect solution to this dilemma. You made the right decision by controlling the downside risk, and you now can either stay on the sidelines or try to find a new entry point.

You are not alone; this happened to me in my advisor practice as well. However, jumping back in, just because the markets moved a couple of percent, may not be the right choice.

While there are probably several options, let me share with you what my process of re-entering consists of. Before establishing a new position, I want to make sure that whatever trend is in place is sustainable.

Say I bought an ETF at $40 and it made a high of $44, before retreating and stopping me out at around $40.50. That leaves me with a slight gain. The markets bob and weave, and this ETF now hovers around the $41.50 level. Should I buy in or not?

Personally, that is not enough confirmation for me to believe that the trend has continued. If I like this particular ETF, and want to reinvest in it, I want to see the old high of $44 taken out before pulling the trigger and establishing a new position.

While this goes against conventional wisdom, I am more comfortable jumping aboard once momentum is accelerating and that means a break out to the upside.

Keep in mind that this is in no way an exact science but merely my way of trying to avoid another whip-saw by letting the market show me the way. If this ETF makes new highs, that to me confirms a resumption of the uptrend. If it doesn’t, I am glad I stayed on the sidelines.

About Ulli Niemann

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