You did your research and you bought a stock that could become a big winner. Now what?
One of the biggest problems that investors have is determining the proper time to sell their stocks. After all, it is easier to be objective when you are deciding what stock to buy. But when it is time to sell, emotions can quickly creep in and cloud your decision making.
To make money in stocks, you must protect the money you have. Live to invest another day by following this simple rule: Always sell a stock it if falls 7-8% below what you paid for it. This basic principle helps you cap your potential downside. And it is the simplest way to make sure you never let a small loss become a BIG one.
The 7-8% sell rule is based on an ongoing study covering over 100 years of stock market history. Even the best stocks will sometimes breakout and then drop slightly below their ideal buy-point. When they do, they typically do not fall more than 8% below it. If your stock does decline more than 8%, it usually means something is wrong with your chosen entry point, the company, its industry, the general market, or all of the above.
Even if you sell at an 8% loss and the stock quickly rebounds, it does not mean you made the wrong decision. You were proactively protecting your portfolio. Taking a small loss from time to time is like paying an insurance premium to make sure you don't suffer a devastating hit. And you can always buy a stock back if it shows strength again.
In a particularly weak or volatile market environment, you may choose to limit your loss, say, at 3-5%. Your stocks do not operate in a vacuum. The trend of the overall market has a significant pull on virtually all stocks. That is why it is critical to always view your stocks within the context of the general market. Are we in the early or later stages of a bull market cycle? Is the uptrend starting to weaken and show signs of rolling over into a correction (i.e., a Downtrend)?
You don't need to hit home runs to win the investing game. Focus on getting base hits. To grow your portfolio substantially, take most gains in the 20-25% range. Though contrary to human nature, the best way to sell a stock is while it's on the way up, still advancing, and looking strong to everyone.
As William J. O'Neil says, "The secret is to hop off the elevator on one of the floors on the way up and not ride it back down again."
So, after a significant advance of 20% to 25%, sell into strength. When you sell like this, you won't be caught in heart-rending 20% to 40% corrections that can hit market leaders.
The Rule of 72
This simple calculation shows how effective following the 20-25% profit-taking rule can be.
Here's how it works: Take the percentage gain you have in a stock. Divide 72 by that number. The answer tells you how many times you have to compound that gain to double your money. If you get three 24% gains — and re-invest your profits each time — you will nearly double your money. It's much easier to get three 20-25% gains out of different stocks than it is to get 100% profit out of one stock. Those smaller gains still lead to big overall profits.
An Exception to Taking Profits at 20-25%
If your stock gains over 20% from the ideal buy point within 3 weeks of a proper breakout, hold it for at least eight weeks (The week of the breakout counts as Week One).
If a stock has the power to jump over 20% very quickly out of a proper base, it could have what it takes to become a huge market winner. The eight-week hold rule helps you identify such stocks, and helps you sit tight so you can reap potential rewards.
Once the eight weeks from the original buy point have passed, you can sell to lock in your gains or continue to hold. If you have a solid gain, and the chart action and general market are still strong, you may want to sit tight and see how the story plays out. It could be a stock that goes on to even bigger gains.