Sitting on losses is never a good strategy because those losses can pile very quickly. Even strong stocks can dive and give up all gains from a buy point in a single session. That is why watching for sell signals and knowing how to sell stocks is vital to investing.
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There are different ways of finding topping signs. Chart analysis offers a clear clue through IBD's 7% sell rule. The sell rule is a simple and effective way of cutting your losses in a disciplined manner.
When a stock breaks out of a base, watch out if it falls below the base's buy point. This in itself is not a sign of a failed break out. However, if the stock falls 7% or more below the entry, it triggers the 7% sell rule. It is time to exit the position before it does further damage.
That way, investors can still be in the game for future opportunities by preserving capital. The deeper a stock falls, the harder it is to get back to break-even. A drop of 7% takes a 7.5% gain to fully recover. A drop of 20% takes a 25% rebound. A 30% decline takes a 42.9% bounce.
The 7% stop loss applies to any stock purchase at any level. If you bought a stock at 45 and the buy point was at 43, you want to calculate the 7% sell rule from your purchase price.
Selling Stocks: Advantage For Small Investors
The 7% sell rule is one of the tools nimble investors have that larger funds that hold massive positions among a wide range of stocks may not.IBD founder William O'Neil would point out that it is "a terrific advantage" that the nimble and decisive individual investor has over the institutions.
Shares of Meta Platforms (META) broke out of a flat base with a buy point of 377.55 on Aug. 30, 2021 (1). Volume was lower than average, which could have alerted a watchful investor. Shares rose to 384.33 but quickly started to fall.
The stock fell below its 50-day moving average on Sept. 20 (2) — the first sign of trouble.
That same day, Meta's dropped as low as 349.80. That was a 7% decline (to 351.12) from the buy point.
Two days later, the stock gapped down and the 7% loss was quite clear by now. Shares plummeted to 88.08 by November 2022. That's a loss of 77% from the August 2021 entry.
Meta didn't get back to its August 2021 levels until January 2024. Investors holding on to its shares from the sell signal would have waited more than two years to get back to break-even. But those who sold in September 2021 would have the capital to get back into the stock for its 2023 rally.
How To Sell Stocks: Market Conditions Matter
The 7% sell rule holds true in bull markets. But in a bear market, it may be wise to exit earlier if the stock falls 3% to 4% from a buy point after a breakout.
The 7% sell rule is one of the simplest rules investors can follow. IBD had been calling it the 7%-8% sell rule, but as a practical matter, it is treated as a 7% loss trigger.
This article was originally published July 14, 2023, and has been updated. Please follow VRamakrishnanon Twitter for more news on the stock market today.
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FAQs
If the stock price drops to the 7-8% threshold, sell the stock to prevent further losses. The "7-8% loss rule" is a risk management strategy commonly used in stock trading and investing. This rule suggests that an investor should sell a stock if its price falls 7-8% below the purchase price.
What is the 7% rule in stocks? ›
However, if the stock falls 7% or more below the entry, it triggers the 7% sell rule. It is time to exit the position before it does further damage. That way, investors can still be in the game for future opportunities by preserving capital. The deeper a stock falls, the harder it is to get back to break-even.
What is the 3-5-7 rule in trading? ›
The 3–5–7 rule in trading is a risk management principle that suggests allocating a certain percentage of your trading capital to different trades based on their risk levels. Here's how it typically works: 3% Rule: This suggests risking no more than 3% of your trading capital on any single trade.
How to protect investments from stock market crashes? ›
Portfolio diversification
A diversified portfolio can be one of your best defenses against the effects of a stock market crash. Diversification means having the appropriate mix of stocks, bonds, cash and perhaps alternative investments that is aligned with your investing time horizon and your risk tolerance.
What is the golden rule for stop-loss? ›
The golden rule of Stop Losses is that they should never be moved away from the market once the trade is opened. If a trader feels that their stop loss is incorrectly placed, they are recognising that the foundations of their trade are incorrect and therefore they should close out.
What is the best stop-loss rule? ›
The best trailing stop-loss percentage to use is either 15% or 20% If you use a pure momentum strategy a stop loss strategy can help you to completely avoid market crashes, and even earn you a small profit while the market loses 50%
What is the 80 20 rule in trading? ›
In investing, the 80-20 rule generally holds that 20% of the holdings in a portfolio are responsible for 80% of the portfolio's growth. On the flip side, 20% of a portfolio's holdings could be responsible for 80% of its losses.
What is the 11am rule in stocks? ›
The logic behind this rule is that if the market has not reversed by 11 am EST, it is less likely to experience a significant trend reversal during the remainder of the trading day. This is particularly relevant for day traders who typically close out their positions before the market closes at 4 pm EST.
What is the 60 30 10 rule in trading? ›
The 60:30: 10 Principle Explained
On average, the markets are in a trending mode only about 30% of the time, breakout mode only about 10% of the time and in a counter-trend, or ranging mode about 60% of the time.
Can I lose my 401k if the market crashes? ›
The odds are the value of your retirement savings may decline if the market crashes. While this doesn't mean you should never invest, you should be patient with the market and make long-term decisions that can withstand time and market fluctuation.
Do you lose all the money if the stock market crashes? No, a stock market crash only indicates a fall in prices where a majority of investors face losses but do not completely lose all the money. The money is lost only when the positions are sold during or after the crash.
Where is the safest place to put a 401k after retirement? ›
Bond funds, money market funds, index funds, stable value funds, and target-date funds are lower-risk options for your 401(k).
What is the 7 loss rule? ›
The 7% stop loss rule is a rule of thumb to place a stop loss order at about 7% or 8% below the buy order for any new position. If the asset price falls by more than 7%, the stop-loss order automatically executes and liquidates the traders' position.
Is it legal to buy and sell the same stock repeatedly? ›
While the practice is legal, investors who trade the same securities often in a single day are potentially flagged as “pattern day traders" (PDT), which requires adherence to Financial Industry Regulatory Authority (FINRA) requirements.
What is the 8 loss rule? ›
The 8% sell rule is a strategy used by some investors to minimize losses and help preserve their capital. The rule is typically applied when a stock drops 8% under your purchase price—regardless of the situation. Keep in mind that this isn't a hard-and-fast rule.
What is the 6% stop-loss rule? ›
The 6% stop-loss rule is another risk management strategy used in trading. It involves setting your stop-loss order at a level where, if the trade moves against you, you would only lose a maximum of 6% of your total trading capital on that particular trade.
Shares of Meta Platforms (META) broke out of a flat base with a buy point of 377.55 on Aug. 30, 2021 (1). Volume was lower than average, which could have alerted a watchful investor. Shares rose to 384.33 but quickly started to fall.