When to Get Back In

Dear Reader,

“When should I get back after I’ve been stopped out?”

It’s a question that anyone who ever uses trailing stops is bound to ask.

Finally, I’ve worked out a solution.

There’s a lot of math involved but in a nutshell, here’s how the Smart Moving Average indictor works:

1. Make sure that the trend is with you;
2. Wait for a strong move in your direction that exceeds the normal volatility range of the stock;

Here’s how that looked on the S&P 500 following the 2007 – 2009 bear market:

The two key features of the above chart are the new Smart Moving Average, which I’ll tell you more about in just a minute, and the Volatility Quotient (VQ%).

The Smart Moving Average tells us the trend. The Volatility Quotient tells us how strong the move needs to be in order for us to be confident that a bottom is in place.

There’s something really important to note in the above chart.

At the time of the bottom in the S&P 500 in March of 2009, the Volatility Quotient on the index was 20.9%. If we had just waited for an up move that was greater than the bear market VQ%, then we would have gotten long at around 840.

Our new Re-Entry Rule, however, didn’t trigger until the S&P 500 had risen a full 48% off of its low. Waiting for our Smart Moving Average signal to also trigger, kept us on the sidelines until the index reached about 1,000.

Now I realize that, in this case, it would have been nicer to get long the S&P 500 around 840 rather than wait until the 1,000 level but I chose this example because I want you to understand how important I believe it is to not fight the trend.

One of my favorite market maxims is “Opportunity is infinite; capital is finite.” There are sooooo many opportunities in the financial markets to put our money to work that it’s just silly to constantly try to jump the gun on new trends.

As investors in the market batter’s box, we’ve got to wait for the fat pitch.

Why? Because when the right pitch comes, you can hit homeruns – like this:

These are the kinds of moves that my entire investment philosophy – and all of the tools that I’ve built – are designed to capture. These are the kinds of moves that I believe that YOU need to capture as an investor in order to be successful.

That’s why I created my new Smart Moving Average indicator… and why I use it as primary component of my new Re-Entry Rule strategy. That’s why I’ll soon be adding it to the arsenal of market-beating weapons available to my TradeStops subscribers.

What exactly is my new Smart Moving Average indicator? Let me explain.

My short hand for Smart Moving Average is SmMA (so as not to confuse it with an SMA or Simple Moving Average).

The math behind the SmMA is complex but the concept is simple – find the moving average that was:

1. The best support for longer term trends; and
2. That provided the biggest bounces when price came down to touch support.

We use about six years of historical data when computing the SmMA and, as always, we’re looking for indications that help us to stay invested for at least six months to a year or more. We also give recent data more weight in order to catch market turning points a bit sooner.

The current SmMA on the S&P 500 is 197 days. You can see on the following chart the this 197 day weighted moving average has done a great job of supporting longer term trends – in both bull and bear markets.

Now that you know a little bit about how the new SmMA works, let’s take a look at how our new Re-Entry Rule worked on the S&P 500 over the past 40 years.

The following chart shows all of the Re-Entry Rule triggers along with Smart Trailing Stop exits on the S&P 500 from 1974 to 2015:

Here is a table showing the details of all of these trades:

All in all, there were 15 such trades over a 40 year period and 12 out of the 15 trades were profitable with average gains of nearly 20%. Moreover, there were some very large winners of 40%, 65% and 105% while the three losers were all less than 10%.

That works for me!

Here’s another way to look at it.

The following chart shows what would have happened if you had used my Re-Entry Rule strategy on all of the individual stocks in the S&P 500 vs. just buying and holding the S&P 500 itself. The vertical axis here shows how many dollars of profit were made for each dollar of risk taken.

Over the last 20 years you earned a bit more per dollar of risk taken if you bought and held the index but you took a lot more risk in order to do so! The Re-Entry Rule strategy perfectly threaded the needle between the extreme highs and lows of the broad US stock market.

Now remember, we’re not looking to this new Re-Entry Rule to be our only way of buying into the market. We’re looking for a solid and robust indicator of when we can buy back into an investment that we’ve been stopped out of but that we still love.

As such, we’re looking for something very stable… and very reliable. We’re looking for strategies that maximize our returns and minimize our market stress.

As with nearly everything I do, I’m looking for ways to tame the wild-eyed frenzied investing beast within who always seems to be fretting or frothing over something.

One of the biggest psychological hurdles of using trailing stops is that our stops will be triggered and the inner investing beast will shout, “If I exit here, it might turn right back around and start going up again!”

Keeping my new Re-Entry Rule in your back pocket will allow cooler heads to prevail and reply, “That’s true, but we can always get back if and when the Re-Entry Rule is triggered.”

Next week I’m going to share with you how we can put all of these new tools together into a powerful new profit maximizing (and stress minimizing) system.

To the growth of your wealth… and your peace of mind,