When To Sell

Knowing when to sell is probably the most important aspect of investing, not to the mention the most difficult.  Many investors don’t have a plan in place to preserve capital or lock in profits.   In addition, the human emotions of hope, fear and greed lead many to sell when they should hold and hold when they should sell.  The goal with any trading strategy should be to make the process as mechanical as possible by adhering to rigid rules.

Preserving Capital

What’s the #1 secret to successful investing?  Are you ready?  Yes, that’s right.  It’s not to lose money.  To be more specific, if you cut your losses at 5-10% when you are wrong, you will be much more successful.  It’s all about capital preservation.

  •  An 8% loss on your investment, takes an 8.7% gain to recoup your loss

  •  A 20% loss on your investment, takes a 25% gain to recoup your loss

  •  A 50% loss on your investment takes a 100% gain to recoup your loss.

As you can see, the larger the loss, the greater the difference between that loss and the gain required to recover your losses.

Taking Your Profit

3 To 1 Profit and Loss Strategy

William O’neill of the CANSLIM method recommends using a 3:1 Profit and Loss strategy.  With a 3:1 strategy, you can be right only 33% of the time and just about break even.  That is very important to remember.  You can be wrong more than half the time and still make a profit if you keep losses small.

  • Lock in profits at 20-25%, while keeping losses at 7-8%

When To Hold For Much Larger Gains

Locking in profits at 20-25% is a sound profit taking strategy for most stocks, but there will be times when a stock exhibits characteristics of big winner.  A homerun stock!  You want to find a few homerun stocks that will gain 100% or more in order to offset your small losses and provide a big gain for your portfolio.  The companies you have unearthed by ringing them through the filter all have characteristics of former big winners, but just a handful will provide huge gains.

  • Stocks that gain 20% or more in the first 3 weeks after breaking out, it should be held for a minimum of 8 weeks.  These stocks have have the potential to provide huge returns.

Note: The above percentages are general guidelines.  When making a sell decision it’s important to take into account the price/volume action and support/resistance areas.  In a choppy market I may settle for a 2 or 2.5% to 1 win loss ratio.

Selling the Homerun

So all your hard work has paid off and you’ve finally purchased a stock that has bolted to gains of 125% over the last few months.  There are no cut and dry rules for selling these stocks, but there are a number of things to look for that may signal the end of the run. 

  • New Highs On Low Volume
    If a stock has had a nice run, but makes new highs on decreasing volume, it means institutions are

  • Exhaustion Gap and Climax Run
    An exhaustion gap and resulting climax run usually signals that the run is over.  This will occur at the end of a long run and the stock is in the media spotlight.  Everyone knows about the stock, it’s been featured on CNBC and a major financial publication.  The exhaustion gap is a flurry of last minute buying out of greed and it signals that there are few buyers left to propel the stock higher.  The stock may run up 25% or more in a short time.  It is your clue to sell.

  • Extension Above Major Support
    Look to sell if the stock climbs 50-75% above the 50DMA or 100-125% above the 200DMA

  • Violation of Long Term Trend Lines Or Support Levels
    If a stock breaks through an upper level trend line it may be near a top.  On the other hand, if a stock breaks below major support at the 50DMA , 200DMA or lower trend line, it no longer has institutional support.  This should be your final warning to get out.
  • Base Stage
    By the time a stock begins to carve out a 4th stage base, it is probably overvalued as the general public has caught onto it.  Stocks rarely perform a successful breakout from late stage bases.

  • Excessive Stock Splits
    More than one stock split over the course of a year can derail a stock.  Not only does it increase supply, but it usually occurs after most investors have become aware of it.

  • Media Frenzy
    If you find your big winner on the cover of Forbes or featured on CNBC, chances are good that those who want to purchase the stock already have or will soon.  If you run out of buyers, the only place for the stock to go is down.

Sell Signals QCOM Part I Sell Signals QCOM Part II