Smart Stops for 04 23 10

As you know one of the ways in which we protect accounts from large declines is to make use of sell stops. Since no one can predict the future and our gut instincts seem to fail us at crucial turning points, it is essential to make use of a safety net of some kind.

Sell stops are essentially lines drawn in the sand. If the share price of one our portfolio holdings drop below a certain price (sell stop) a sell signal will be given. Sell stops should be loosened up during strong market uptrends (helps keep you invested during the normal market fluctuations) and tightened in sideways or declining markets when a change of trend may be imminent.

SmartStops is a service I subscribe to that takes the current trend strength in to consideration when determining effective and productive sell stops and re-entry points.

While Trend Line Analysis (discussed in previous blogs) is still the primary tool we use to guide us, smart stops are an important secondary line of defense.

The chart below shows the smart stops and potential re-entry points for various sector ETFs. Many moderate risk accounts currently hold XLY and XLI. Notice that the health care ETF (XLV) received a SmartStop sell trigger alert today. Had we owned XLV, it would be sold tomorrow.

(Click on chart to enlarge it for easier viewing)

note:

Short-term smart stops are more conservative and do more to limit portfolio volatily, but result in more transactions and whipsaws.

Long-term smart stops are more aggressive and create more portfolio volatility, but result in less transactions and less whipsaws.



Whipsaw


What Does Whipsaw Mean?

A condition where a security's price heads in one direction, but then is followed quickly by a movement in the opposite direction. The origins of term is derived from the push and pull action used by lumberjacks to cut wood with a type of saw with the same name.

Investopedia explains Whipsaw

There are two types of whipsaw patterns. The first involves an upward movement in the share price, which is then followed by a drastic downward move, which causes the share's price to fall relative to its original position. The second type involves the share price to drop for a little while, and then suddenly, the price abruptly surges towards positive gains relative to the stock's original position.
       

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