Recently, we received a question about exchange traded funds (ETFs) from a reader, specifically dealing with when to hit the escape button on a fund. As it happens, we have an answer.
I have a couple of questions about your suggested exit strategy. Your idea is to set a stop-loss at 8% below the recent high. My first question is, for this purpose would you recommend using the high closing price, or the highest intraday price?
Secondly, in a situation such as the present, after many investors have gone completely to cash, and no one knows whether the low of the cycle has been reached or not, the idea of possibly losing a few more percent each time I try to start investing again is hard to take. In such a situation, do you recommend still setting the stop-loss at 8% of the recent high, even though that may be below one’s purchase price?
We often talk about our strategy for entering the market, which is to use the 200-day moving average as a guide. When a fund crosses that key mark, it’s worth consideration. It isn’t the only thing we consider, but it’s the first thing that has to occur. We also look at other factors such as holdings (is it diversified?), weightings (is it heavily weighted in the top three holdings?), trading volume and assets (we like both to be high).
But just as important as having an entry strategy is having an exit one. It can be very difficult to let go when something that has done so well for you suddenly begins to falter. It’s this kind of second-guessing that our plan serves to eliminate. When a fund drops 8% off the recent high, or below its 200-day, we sell.
The answer to our reader’s question, then, is this: we use 8% off the recent closing high as the sell-point. We also always adhere to the 8% stop loss. There is always the chance of whipsaws, but staying out of the market until we feel good about investing might allow us to miss a good chunk of the next rebound.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.