It is said the easiest part of investing is knowing when to buy. The hardest part of investing remains the ability to know when to sell. After all, buying at the right price may lead to profits. Selling at the right price guarantees the profit. But, if you don’t sell at the right time, all the benefits of buying at the right time disappear. Sounds simple, but many investors and traders had to learn this the hard way. It is very difficult to master the most important rule of investing – knowing when and what level to sell.
The first and most important lesson to learn when investing continues to be damage control or understanding when to cut your losses short to prevent a small loss (cut) from turning into a major loss (hemorrhage or worse). Psychologically, no investor wants to sell for a loss or to leave profits on the table. The emotional aspect of investing can hurt an investor and specifically a trader the most. Successful and experienced investors have learned, often through painful lessons, that knowing when to sell is as important as knowing when to buy. So, the question then becomes – how do you know when and at what price to sell?
A trailing stop loss sell strategy may be an effective way to protect a profit and define the investment’s downside risk while at the same time allow the profits to run on the upside. Some will advocate establishing a trailing stop order to sell their long position at 5% below the current price. Others will recommend assigning a sell stop loss level at a fixed percentage or x number of points below the original buy price level. Yet others will deploy a sell stop based on the security's implied volatility or historical standard deviation band.
We believe there are pros and cons in deploying the above trailing stop loss strategies. However, in our view the most effective way to determine where to establish a trailing stop loss is to place the trailing sell stop order just below a key technical support level. For instance, for a short-term trader it may be the 30-day or 50-day moving average. On the other hand, an investor with a longer-term time frame it may be below the 150-day or 200-day moving average.
Depending on your timeframe and your risk tolerance level this will likely determine where to establish the trailing stop loss. However, the strongest area to assign a trailing stop loss is when key technical disciplines all converge together at or near the same technical support zone. That is, when a key moving average (i.e., 50-day or 200-day) is near its key uptrend, or along a prior major breakout, or close to a pivotal reaction high/low, or a pivotal Fibonacci retracement, or close to significant gap up/gap, etc. This convergence zone then becomes very strong support as buyers will likely defend the security here.
Given the sharp rally in major US stock indexes this year many investors and traders have considerable paper profits. We suspect many are seeking to protect their gains but do not know where the correct levels to place their trailing stop loss. Attached below we have updated the key technical support levels for US indexes including SPX, INDU, COMPQ, NYA and NDX. The support levels associated with asterisks (* and **) are considered key technical supports. At these support levels, buyers are likely to return and sustain the current primary uptrend. On the other hand, convincing violations of these supports warn of the start of the next major decline.