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. No questions asked.
This basic principle helps you cap your potential downside. And it's the simplest way to make sure you never let a small loss become a BIG one.
Why 7%-8%? The 7%-8% sell rule is based on our ongoing study covering over 130 years of stock market history.
Even the best stocks will sometimes break out and then drop to 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.
Sometimes you'll know the reason. Other times you won't. But you do know the stock is dropping, and you're sitting on a 7%-8% loss. You must immediately shift into capital-preservation mode and cut that loss short.
Once a stock begins to plunge dangerously there's no telling where the bottom is. Limit your loss to 7% or 8% and get out. Imagine an ax hurtling through the air coming right at you. Would you stand there trying to figure things out? Just step aside.
Your #1 priority is to preserve capital. Sell first, ask questions later.
Applying the 7%-8% Sell Rule If you buy a stock at 100 and it falls to 92 or 93, sell it. But if that stock rises to 150, and then slips 8% to $138, that does not trigger this particular sell rule, because the stock is still trading above your purchase price. (Of course, you may want to check to see if the stock is flashing any other warning signs and sell signals.)
The 7%-8% Sell Rule in Action Below are examples of why it's important to cut all losses quickly.
What If You Sell and the Stock Rebounds and Moves Higher? There may be times when you sell a stock at a 7%-8% loss, only to see it bounce back and climb higher. While that can be frustrating, be sure to keep things in perspective. Normally if you buy correctly and your stock and the general market are acting well, your stock will not fall 7%-8% below the proper buy point.
So when the stock does trigger that sell rule, take action. Its behavior is telling you something isn't right.
Even if you sell at an 8% loss and the stock quickly rebounds, that doesn't 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 once again shows strength.
Sometimes Sell Even Sooner The maximum loss you should allow is 7%-8%. That's especially true if the stock shows other warning signs and sell signals. Also, in a particularly weak or volatile market environment, you may choose to limit your loss, say, at a 3%-5%.
As we saw in the section on Market Direction, your stocks do not operate in a vacuum. The trend of the overall market has a significant pull on virtually all stocks. That's why it's 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., downtrend)?
These and other market-related factors help you decide what action to take. See Market Direction for tips and tools on how to quickly gauge overall market health.
