In November 2016, the US Presidential election results drove a market rally, causing us to consider selling the SPDR S&P Metals and Mining ETF (XME). We initially purchased XME in February 2016 at $16.32/share.
Prior to the election, XME had experienced a 6-month-long rally, peaking in late July 2016. After about a 10% correction, XME more or less held constant from September through October.
To understand these trends, we look towards the steel industry. Steel dominates XME’s portfolio, making up more than half of its total holdings.
Late October was earnings season, and the 3rd quarter results were mixed for many of the major steel companies: Steel Dynamics’ 3Q16 earnings were close to estimates, Nucor and US Steel both missed earnings estimates, and AK Steel significantly beat analysts’ earnings estimates.
A few factors influenced these earnings.
US steel imports had fallen from July through September, primarily due to a close in the spread between US and foreign steel prices in some types of steel, helping US-based company profits.
For other types of steel, such as flat-rolled, the market had supported an increase in price driving additional profits.
However, raw materials were a concern that affected the market response post-earnings reports.
Iron ore, steel scrap, and coking coal are the primary raw materials that go into steel production. Falling prices in steel scrap favored Nucor and Steel Dynamics, while rising prices in coking coal may negatively impact US Steel and AK Steel.
So what does this all mean? Prior to the election, views on the future of the US steel industry varied resulting in a flat response in XME’s market price.
In the days up to the US presidential election, there was cautious optimism about the effect of either candidate on the steel industry.
Both candidates stated their desire to increase spending on infrastructure, with Trump’s planned allocation doubling Clinton’s. Therefore, a Trump presidency could significantly increase the US demand for steel.
Trump’s planned trade policies could stem imports, further increasing business for US-based steel corporations.
However, these policies are not guaranteed to get through Congress, and the positive affects may be short-lived.
In the end, the election of Donald Trump as the next President of the United States on November 8th caused the market to rally.
One effect this rally had on our portfolio was increasing the value of XME above our Absolute Sell Threshold, shown in the graph below.
If you’ve signed up to receive our updates, you’ll know that there has to be a really good reason for us to continue to hold an ETF past the Absolute Sell Threshold.
In late July, we believed the rally would keep going strong so we did not sell, even after XME crossed the threshold. This time, for all the reasons explained above, we had reason to believe that this rally would be short-lived. The data indicated sector fundamentals would eventually end the post-election “high” and result in a correction, so it was time to lock in profits.
But what if the market was really going on a long rally? We don’t want to miss out on the profits if the ETF blasts through our threshold! Luckily, there is a great tool to help out — the trailing stop order.
Trailing Stop Orders
The trailing stop order is my favorite investor tool. It can be used for both buying and selling securities, but for the purposes of this article we’ll focus on how it can be used to sell and secure a profit.
The way it works is quite simple, but rather ingenious.
Rather than just selling a stock or ETF at its current price, a trailing stop order allows you to set an amount in either dollars or a percentage below its current market value that will drive a sale.
If the stock increases in value, the trailing stop increases along with it. If the stock decreases in value, the trailing stop holds constant until either the stock equals the trailing stop amount (resulting in a sale), or it reverses course and increases above its previous peak.
Let’s look at an example — each step is shown graphically with its corresponding figure below:
- The market value of a stock we want to safeguard against future losses is currently $10/share. We set a trailing stop of $0.50, meaning that the stock would sell when it hits $9.50.
- The stock climbs to $11, and the trailing stop increases with it to $10.50.
- The stock drops to $10.75, and the trailing stop holds at $10.50.
- The stock climbs back up to $11.50, and the trailing stop increases with it to $11.
- The stock drops down to $10.80. As the price hits the trailing stop amount of $11, the trailing stop converts to a market order and the stock is sold at $11/share.
Pretty cool, right? However, there is one limitation that is worth noting. If the stock were to drop after-hours and open below the trailing stop, then the trailing stop would convert at the opening price to a market order, resulting in a lower sale price than planned for.
Ultimately, in that case we still protected our self against additional losses and hopefully made a nice profit!
Trailing stop buy orders are very similar, except you set a price above the current market value instead of below. When the stock or ETF price increases up to the stop, a market ordered is triggered at the trailing stop value. This is a good way to catch a stock as it starts its recovery after a drop in price.
Commodities Profit Taking
At the market close on November 7, 2016, XME closed at $26.49, above our Absolute Sell Threshold of $26.21.
At this point, we decided to set a trailing stop order of 3%. On November 11, XME dropped 3% off its high during inter-day trading and triggered a market sale at $28.86, resulting in a gain of over 70% in less than a year!
Looking back at this sale now, keeping in mind that hindsight is 20/20, we probably set the trailing stop tolerance a little too tight.
XME ended up peaking at $33.73 on December 8th; ideally, we’d like to sell a little closer to the peak without losing too much profit as the ETF corrects.
On the next sale, we’ll probably lean a little closer towards a trailing stop of 5% to allow for a bit more fluctuation in the market price.
Overall, XME was an excellent demonstration of our strategy’s benefits, and we’re very happy with the results.