In a trailing stop order, the stop price rises with the market price as long as the stock is going up. If it starts going down, the stop price freezes. For example, if a trailing stop order is set at 10% below the market price it would move from $9 to $18 if the stock price doubled from $10 to $20. Should the stock fall from $20, the stop would remain at $18 and a market order to sell would be triggered if it reached that level. 

Advisors have all kinds of systems and formulas for setting stop orders depending on the stock's volatility or some other consideration.

Jack Reutemann, president of Research Financial Strategies in Rockville, Md., typically sets 5% trailing stop losses on diversified domestic ETFs, and 7% trailing stops on more concentrated sectors or emerging market positions. He says that because those stops kicked in a couple of days before the flash crash, his portfolios were 100% in cash when it hit.

He admits that setting such tight stops triggers more short-term trades and higher taxes from short-term capital gains.
Occasionally, he gets "whipsawed" out of positions when an ETF bounces back quickly. But to clients, he says, such issues are fairly minor as long as the technique is profitable. "Being taxed on gains is better than paying no taxes on losses. Buy and hold is not gospel. It's a body of opinion."

Landolt, however, doesn't use stop orders of any kind. "I've spoken with almost all the major ETF providers and they tell me that it's important not to place market orders if pricing is a significant issue to you," he says.

Instead, he sells whenever he rebalances his portfolios-which could be once a year or once a month, depending on the strategy. He places sell orders when the market is fairly calm to avoid surprises in pricing or execution, and will usually wait at least 45 minutes to an hour after the market opens to make sure he's selling in a relatively stable environment.

When he has a large sell order, he contacts ETF providers and asks them about trading activity and the execution price he can expect to get. "I've found that they're happy to work with me to get the best price possible," he says.

To help ensure a favorable execution price, Lydon will contact the trading desk at his brokerage firm instead of placing a market order to sell, particularly if he is dealing with a large position in a thinly traded ETF. The broker will then confer with an ETF authorized participant-usually an institutional investor, specialist or market maker that has a special agreement with a particular ETF sponsor or distributor to come up with an execution price. "Usually, the price I get falls somewhere between the bid and the ask price," he says.

Lydon also avoids using stops. "Most of the time we're watching the market from open to close, so we don't need an automatic system for triggering sales," he says. "A lot of advisors have switched from simple buy-and-hold strategies to those that are more fluid and tactical in nature. That requires watching the market more carefully and not becoming too dependent on automated systems."

If a stop is occasionally necessary, he recommends stop limit orders over stop loss orders because the trade won't get executed if the price of the stock falls through the limit in a rapidly declining market. By contrast, a stop-loss order guarantees execution, but not price.