Financial Literacy

A Smart Stop That Won’t Prematurely Buck You Out of Stocks

Editorial Note: Last week’s historic market drop (and subsequent recovery) bucked a lot of investors out of longstanding positions – positions that, in many cases, they weren’t planning to sell. In the days since, we’ve received several messages about the use of trailing stops. Matthew Carr and Alexander Green responded to comments here and here, respectively. But for another valuable perspective, we’d like to introduce Dr. Richard Smith.

Richard is an Oxford Club Member and the founder of TradeStops.com, a Web-based stock tracking program. TradeStops automatically follows users’ portfolios – and issues alerts when “Smart Trailing Stops” are hit.  (If this all sounds familiar, you may be remembering Alexander Green’s rundown on Richard’s system here.)

For today’s Investment U, we wanted to share a (admittedly bearish) note Richard sent out to his subscribers about the recent volatility in stocks – and how the right type of stop can help you stay in your winners.

Serious damage has been done to the financial markets in the past two weeks – very serious.

No one should be kidding themselves that what’s happened is just a little late summer blip – building up some energy to rally into the fall and winter. I’m not saying it couldn’t happen, but it isn’t the odds play.

Everywhere I look, technical damage has been done – and it’s like nothing we’ve seen since 2008.

Here’s an update on the dozen or so charts I’ve been following for the past month using my three proprietary indicators:

  • Smart Moving Average – a proprietary trend indicator that tells you if the trend is your friend.
  • Low Risk Zone Border – the price at which a stock has pulled back enough to be interesting but not too much to be in danger.
  • Smart Trailing Stop – the volatility-tuned stop loss level that tells you when a stock has pulled back more than it should have.

First, we’ll take a look at the major indexes – the S&P 500, Dow Jones Industrial Average and Nasdaq 100. All three have moved beyond their normal volatility ranges for the first time since early 2009.

The indexes have all penetrated their Smart Trailing Stops. Additionally, the Smart Moving Averages are also rolling over in all three cases.

You can see it more easily here when we zoom in on the S&P:

However, as you can also see above, the major indexes have all promptly risen right back above their Smart Trailing Stops.

I can feel the collective relief of the media. It’s as if everyone is saying, “I have no idea what just happened there, but I’m glad it’s behind us now.” This correction is being portrayed as if it were the temper tantrum of a 2-year-old – fierce but quickly forgotten.

Yeah, right.


If it were just the major indexes that got whipsawed like this, it might be one thing. But incredibly, every single one of the nine SPDR Sector ETFs that we’ve been following has also broken its Smart Trailing Stop.

This is not normal market action. It’s not the “pause that refreshes” prior to an end of the year rally.

Of course, anything can happen. But I’m increasingly concerned about the damage that has been done and the complacency I’m seeing in the media. I’m personally happy to see my stops getting hit and giving me the opportunity to move some capital to cash.

If the markets rally right back up from here, my Re-Entry Rule indicators will get me back in. I will have definitely lost a small chunk of gains, but I’d rather risk that than risk seeing a market meltdown that gives back all of the hard-fought gains of the past six years.

By the way, not everything is gloom and doom in the markets. Believe it or not, there are many opportunities performing quite well.

I’ve recently put together a list of 300 different equities and ETFs that I monitor with my SSI toolbox – a proprietary checklist that factors in my Re-Entry Rule, Smart Trailing Stop and Low Risk Zone indicators. The lists covers stocks from the S&P 100, Nasdaq 100 and a group of about 100 ETFs such as the above sector-focused ETFs.

Let me show you a few examples of equities that are still performing incredibly well.

From the S&P 100, both Home Depot (NYSE: HD) and UnitedHealth Group (NYSE: UNH) are still going very strong. Since triggering Re-Entry Rules in 2009, both have been unstoppable and very well behaved. Home Depot is currently up 426% since then, while UnitedHealth is up 362%.

Other stocks from the S&P 100 that are thumbs-up per their SSI include well-known names from biotech, retail, defense and healthcare.

Finally, I’ll leave you with this incredible example from the Nasdaq 100 – Regeneron Pharmaceuticals (Nasdaq: REGN).

It’s a stunning example of the power of staying in your winners… by trusting your exit strategy.

It’s been a liberating experience for me to be able to more or less ignore the news during the recent market mayhem. I hope it has been for you too.

To keeping your head when all about you are losing theirs,

Richard M. Smith, Ph.D.
CEO, TradeSmith
Founder, TradeStops.com

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