SSI Stock Investing in the Red Zone
My mantra at TradeStops is you’ll have the best chance for success if you invest only in stocks with an upward momentum that aren’t in the SSI Red Zone. That is far and away the safest strategy to stay out of trouble for the majority of investors.
But I realize that for many investors, there are valid reasons to hold stocks in the SSI Red Zone. You might have low cost-basis stocks on which you don’t want to pay capital gains. You might have a high conviction idea that you don’t want to use a stop-loss strategy for. You might participate in an employee stock purchase plan.
There are two things that should be considered when owning stocks in the Red Zone.
The first is that even if you have stocks in the Red Zone, you want to be sure that your portfolio remains “right-sized.” This means looking at your portfolio on an annual basis and being sure that you’re taking an equal risk per position so that you have more money invested in your more conservative stocks and just the right amount of money in the riskier stocks that can blow up your portfolio.
This simple but profound position-sizing strategy more than doubled the average performance of over 40 individual investors over a 16-year period. The blue line in the chart below shows the impact of this strategy on improving the performance of this group versus the black line, which is their original collective performance.
Having an intelligent approach to position sizing is serious stuff that should never be overlooked or underestimated.
While smart position sizing is something I’ve talked about many times before, my second suggestion for what to do when you hold stocks in the Red Zone is a new one.
This year we’ve written multiple times about a sector-based strategy for beating the S&P 500 using the 9 ETFs of the Select Sector SPDR ETFs from State Street. We wrote about it here and here.
One of the most interesting parts of that research for me was the question of when to go completely to cash. In the original study, we used a rule that if 3 or more of the 9 sector ETFs were in the Red Zone, we discontinued adding any new positions and sat on the cash. Only after 7 of the ETFs were back in the Green zone or Yellow zone were new purchases made. That was a very powerful rule.
We recently expanded on that research and asked the question, “How much of a portfolio’s capital can be safely invested in stocks that are in the Red Zone?”
The answer that we came up with is 40%.
Now before I go any further, I implore you to please be careful with this idea. This is not an endorsement of putting up to 40% of your portfolio into stocks in the Red Zone. I still feel strongly that the majority of our portfolios should be in stocks that are in the Yellow Zone or the Green Zone.
What I will say today is that if you are going to be invested in stocks that have a red SSI, then make sure that no more than 40% of your portfolio’s dollar value is invested in these stocks.
Why do I say this?
The below chart takes a little time to understand but it tells the story.
What it shows is a system that is in the market when 60% or more of the portfolio’s capital is not stopped out and is out of the market when 40% or more of the portfolio is stopped out.
The bottom area of the chart shows the % of the portfolio not stopped out. The red line is the critical threshold at 60%. As long as more than 60% of the portfolios assets are in the Green Zone or Yellow Zone, it’s smooth sailing. When 40% or more of the portfolio’s assets are in the Red Zone, it’s time to step aside from some or all of these positions by either going to cash or investing in other stocks that are in the Green Zone.
So, if you’re going to hold on to some of your Red Zone stocks, you’re taking more risk, but it can work. Just make sure that:
- You’re still using smart position sizing; and
- You never have more than 40% of your portfolio in assets that are in the SSI Red Zone.
Richard Smith, PhD
CEO & Founder, TradeStops
Healthcare Stocks Point To Your Good Health!
The healthcare sector has underperformed the rest of the stock market for most of this year … and particularly for the last six months. That could be changing soon … in a big way.
The SSI chart on XLV, the ETF that tracks healthcare stocks from the S&P 500, tells the story …
XLV literally started and ended 2016 right at $70 per share. It triggered an SSI entry signal in April … right at about $70 per share. Since then, it has risen to $75 and fallen to $66 (all moves within its expected volatility range of 12.8%) and returned again … to $70.
So … why do I think all that could be about to change?
The healthcare stocks sector is trading in a very strong area of support. It went through the SSI yellow zone and came within pennies of hitting the SSI Stop signal (see SSI chart above). It has since moved higher and currently rests just inside the SSI green zone.
The volume-at-price (VAP) chart on XLV shows that XLV is sitting right on its biggest price-volume point at, you guessed it … $70.
Another striking feature of the above chart is the downward price spike that occurred in August of 2015. These kinds of sharp spikes down are very often a sign of higher prices to come because they effectively clear out all the sellers that have been hanging out at lower price levels. These kinds of events are referred to by insiders as “running the stops” or, more colorfully, “wash and rinse cycles.”
This is exactly what happened in the financial sector as well. XLF is the financial sector ETF. Like XLV, it also spiked lower in August of 2015 and, about a year later, moved sharply higher off of strong VAP support.
This same kind of opportunity may be setting up in the healthcare sector right now. The sellers in the healthcare sector have been exhausted. Support has held. The sector is poised for a breakout to the upside … and that upside could be very potent.
Finally, my time-cycles are forecasting a move higher in the healthcare sector for the next four months as well.
The healthcare sector is normally thought of as a defensive sector with the ability to outperform a market that is moving lower. If the markets take a breather, as I suggested last week, the healthcare sector could buck the trend.
To your good health!
Richard Smith, PhD
CEO & Founder, TradeStops
Our Most Important Research
Back in June, we published one of our most important pieces of research of 2016 … how to crush the S&P 500 using just the S&P 500 … plus the TradeStops SSI system. The simple system we published back then beat the S&P 500 by 2 to 1 … and did so with less than half the risk!
I recently asked my team to apply our more recent groundbreaking research to that study to see the impact. I wasn’t disappointed. Trust me, you’re really going to want to see this.
The original study had been prompted by a challenge from one of our subscribers who wanted to know how our Stock State Indicator (SSI) system performed on the S&P 500 vs. a simple buy and hold strategy.
Here is the main stock market indicator takeaway chart.
The SSI system includes an exit and an entry strategy, both based on the TradeStops Volatility Quotient (VQ). The system represented by the blue line above used the SSI system to strategically exit (red down arrows) and re-enter the S&P 500 (green up arrows).
The outperformance of the SSI system here comes entirely from being out of the market during the 2001 – 2003 and 2008 – 2009 periods. The system was also out of the market for a few months in 2015 – 2016 but it lost a little ground by being out of the market during this period.
OK. That’s the backstory. Now … there are two pieces of our most recent research that I asked my team to apply to the original study. The first one is the research we did on how increases in volatility (rising VQ’s) can be used as an additional buy indicator.
In the chart below we can see how in both 2003 and 2009 the VQ on the S&P 500 did indeed increase nearly 100% or more above its long-term average of 10%.
We can also see how the VQ had not substantially increased in 2015 when the SSI gave a signal to exit. Could that lack of significant rising volatility in 2015 have been an indication to stay in the market instead of exit? Possibly … but that research question will have to wait for another day.
I do want to point out that applying the research above to our SPX + SSI system did not have any impact on the results that the system produced. At this point, it is just interesting to see how significant increases in VQ often precede long-term rallies. The final application of this research still remains to be uncovered.
On the other hand, the second piece of research I asked my team to apply had a decisive impact on the results. The research in question is our study on when to add to a winning position.
I don’t have time to review that research in detail here. You can review the article at the link above if you want the nitty gritty (and it admittedly does take a little work to understand). The upshot is to add to a winning position after every 2 VQ’s of gains.
The chart below shows how that looks on the S&P 500. The green arrows are the initial SSI entry points and the blue arrows are points at which we added additional legs to the winning positions.
How did this stock market indicator strategy of adding to our winners perform? It added another 100% of gains beyond the original 100% improvement of just the SSI itself.
Pretty remarkable, isn’t it?
What really excites me about this, besides the obvious profit potential, is that it all perfectly captures my fundamental behavioral insights on investing.
- We have a bias towards our losers that is hard to see at first and even harder to overcome. We have to learn to cut our losses … and stay in our winners. Even the simplest of trailing stop strategies can help us accomplish this. Our volatility-based trailing stop strategies do it better than anything else I have seen.
- The stock market has momentum. What goes down often keeps going down and what goes up often keeps going up. It’s not true all the time but it is true more often than not. It’s better to add to winners than it is to add to losers.
- It’s best to decide how much to invest based on how much we’re willing to lose if we’re wrong rather than on how we feel about the investment.
- The stock market can stay irrational longer than we ever expect. It’s better to limit the role that our thoughts and feelings have upon our decision making. (Note that I said “limit” rather than “eliminate.”)
That’s all folks. 15 years of research and 200% alpha … all grounded in fundamental truths of behavioral finance that you can take to the bank.
Happy New Year!
Richard Smith, PhD
CEO & Founder, TradeStops
Managing Your Alert Notifications in TradeStops
One of the key components to managing the positions in your portfolios is the ability to get alerts when your stocks hit certain targets. And TradeStops lets you set up an almost infinite number of alert types.
The default alert for individual positions is the Stock State Indicator Alert (SSI Alert). This alert is actually five alerts in one. It lets you know when a stock has triggered an SSI Entry signal, when a stock has triggered an SSI Stop signal, and three different alerts when the stock moves into the SSI Yellow Zone. These include whether the stock is up trending, sideways trending, or down trending.
This is the way it looks when the SSI Alert is being set up.
If your accounts are synchronized, you might not even know that these alerts are set up automatically.
But sometimes, less is more. As the market’s climb has paused recently, we’re seeing some stocks trade in narrow ranges, and this can cause new alerts to be triggered several times a week as a stock moves above and then below a certain target price.
Here’s an example.
XLV is the ETF for the Health Care sector. Here is a 3-month chart of XLV.
The stock was in the SSI Green Zone at the beginning of October. Since the middle of October, the stock has moved from the Green Zone into the Yellow Zone and back into the Green Zone. This stock movement has caused 11 SSI Alerts to be generated in the past several weeks.
Each of these alerts are then sent to your email address and your cell phone (if you have the cell option turned on). Multiply this by 50 or 100 stocks, and it’s easy to see how clogged up your inbox can get.
Many of our members have asked if there’s a way to be notified of just two things. They want to know when a stock has triggered an SSI Entry signal, and is moving from the Red Zone to the Green Zone. And they want to know when a stock has triggered an SSI Stop signal, and is moving from the Green Zone to the Red Zone.
This removes the clutter from your inboxes and only alerts you when actionable alerts have been triggered.
It’s easy to do. The first thing we’ll want to do is go to the Templates page. That is accessed in the upper right hand corner of the TradeStops site.
After getting into the Templates page, it will most likely look like this:
The Stock State Indicator is the default. Let’s set up a new default that will only trigger when a stock hits the SSI Entry signal or SSI Stop signal. Just click on the “Add Template” button and by default, it will open on the SSI Alert screen. Click on the “Show Additional Settings” link.
Now, unclick the three boxes that show the SSI Yellow Zone. Then click on “Add Alert,” name the new template, check the “Make Default” button, and then “Save.”
After clicking “Save,” this is how it now shows up in the Templates page.
We’re now set up to make easy changes in our portfolios. Here’s a sample portfolio that contains the XLV example from above. This portfolio shows all of the Sector ETFs, and they all have the normal SSI Alerts. This is how it appears on the “Alerts” page.
By clicking on the box in the upper left hand side, it will highlight all of the boxes. You can then delete all of the alerts. The TradeStops program will ask you if you want to do this.
You’ve now removed all of the standard SSI Alerts. It’s really easy to add the new “Green Zone/Red Zone only” alert that we created earlier. Just go to the “Positions” tab and check the box at the upper left hand side again and click on “Add Alert.”
The last thing you’ll do is click on the alert you want, and you’ll have set up this alert for every position.
It’s that easy. Now you’ll only recieve the alerts that matter to you most.
If you have any questions, please contact our Customer Success team at your convenience.
Best wishes for the beginning of 2017 and your investing success.