Managing SSI Red Zone Trades

The markets are volatile right now — a quick peek at our Market Outlook inside Ideas by TradeSmith bears that out. As of this writing, 11 of the 12 indexes we follow are in the Stock State Indicator (SSI) red zone and the lone exception is in the yellow zone.

But there is always opportunity in the market and, as always, our system is merely one approach to investing. You may decide that there are one or more stocks you want to invest in that are in the red zone.

Two months ago, we looked at reasons an investor might want to buy stocks in the SSI red zone. At that time, the market was moving higher and there was no sign of the volatility that we’ve seen the past five to six weeks.

We looked at two examples of stocks in the red zone, but with different outlooks. The first stock we looked at was General Electric (GE). GE has been in the SSI red zone since May 2017. It’s been the poster child of a stock to avoid for a long time.

This past September, the stock was trading at the $13 level, which was a 50% move lower from the SSI Stop price the previous May. Since September, the price has dropped an additional 40% and is barely hanging above the $8 level.

The second stock we looked at was Johnson & Johnson (JNJ). JNJ was also in the red zone in September, but was climbing higher. We speculated at that time that it was only a matter of time until JNJ triggered a new SSI Entry Signal, which it did on Oct 1. It has been in the green zone ever since.

As we discussed earlier, volatility has increased and a large number of stocks are now in the red zone.

What’s the best way to manage these trades should you choose to take the risk? At TradeSmith, we believe that every trade should have an exit strategy based on math, not on hope. We understand that it’s difficult to sell during a bad market, especially if the sale is going to result in a realized loss.

TradeStops offers a number of solutions to this problem on each individual Stock Analyzer page. The Volatility Quotient (VQ) gives you the normal volatility of any stock or fund over a 12 to 36-month period of time. If you feel that a stock is due for a turnaround from the time you purchased it, you want to give the stock enough room to have its normal volatility. In the case of GE, the VQ is 19.3%.

To the right of the VQ are three different Stop Loss strategies. If the stock is in the SSI Red Zone, there will be no SSI Stop Loss listed, so you won’t be able to rely on SSI alerts as an exit strategy. The next line, the VQ Stop, is the previous closing price minus the current VQ. That is a stop loss that makes sense for most stocks, especially if they’re trading in the SSI Red Zone. You’ll also find the traditional 25% trailing stop listed as an option.

There are many reasons to own stocks in the SSI Red Zone, especially in this market. By using an intelligent stop loss such as the VQ, you can continue to limit your downside and take advantage of a stock that could do well when the market rebounds.

As a side note, you can set up customized alerts for positions based on a VQ exit strategy. Look for more details on how to do that in this week’s Insider.

Marina and I will be discussing portfolio exit strategies and managing stocks in the SSI Red Zone during our next educational webinar, Wednesday, Nov. 28 at 1 p.m. ET. Click here to register.

Cheers,

Tom Meyer
Research and Education Specialist