A sell stop is a vital part of protecting the bulk of your portfolio in case of sudden trend changes. Of course, the other side of the coin is that you may get stopped out, the trend reverses again, and prices head higher leaving you on the sidelines.
That’s a classic whip-saw and simply the price you have to pay in order to not go down with the sinking ship as many did last year and in 2000.
Reader Wade had this comment:
Yes, sell stops work to get out of the market with minimal damage, but what type of rule do you follow to get back in after the market turns around?
First, let me clarify that this is not an exact science, there is a little bit of guesswork involved.
Let’s use an example of how you might find a new entry point. Say, you bought an ETF at $10 and the price, over time, rises to $11.00, which becomes your high point from which to measure your 7% trailing sell stop. That would make your trigger point around $10.23.
Let’s assume that this sell stop gets triggered and you get out of the position at around the above price, give or take a few cents. Now the trend reverses again and prices head higher with your old ETF now crossing the $10.60 level.
You have decided that you like this ETF and want to establish a new position, but when and at what price point?
As I said, there is no hard and fast rule that guarantees a positive outcome. Trend tracking is based on jumping aboard funds/ETFs as they are advancing and showing strong upward momentum.
Personally, I would consider re-entering once the old high has been taken out. In this example, it means prices have to break above the $11.00 level before I make a new commitment.
While that does not give you any assurances, you are entering at least with the trend being on your side. At the same time, you need to establish a new sell stop point in case this turns out to be another head fake.
My point is that you are better off keeping your emotions in check by following a methodical approach for dealing with these uncertainties than going by the seat of your pants.
I firmly believe that if you have a plan in place as to when to buy, when to sell and how to deal with whip-saws, your investment life will become much calmer.
At that time, you no longer need to listen to the hyped-up cheerleaders on the financial news stations promising and touting anything just to keep you tuned in for the commercial messages.