Many new investors wonder when is the right time to sell stocks. An old Wall Street saw has it that nobody ever went broke taking a profit. Actually, that saying isn't 100% correct. You won't go broke so long as your profits are always bigger than your losses.
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For that reason, IBD has long since encouraged readers to limit their downside risk in every trade. Cut losses in each investment at 7% to 8% or less. No questions asked. Just move on to the next trade. The golden rule of selling is as simple as that.
When a stock is going the right direction, your decision making is not as easy. How long should you hold? Here's a specific rule to help boost your prospects for long-term stock investing success: Once your stock has broken out, take most of your profits when they reach 20% to 25%. If market conditions are choppy and decent gains are hard to come by, then you could exit the entire position.
But if the market winds are favorable and your stock appears to be still in the early stages of its run, then go ahead and sell at least part of the position, such as a third or half, to lock in gains. Keep watching the stock's behavior to decide how to handle the remainder.
IBD founder William O'Neil formulated this rule in the early 1960s, when he noticed that most stocks broke out of well-formed bases, ran up 20% to 25%, then corrected sharply in price. O'Neil learned to sell on the way up.
When Not To Sell Stocks: Sometimes This Rule Kicks In
The exception to this sell rule? When a stock runs up 20% or more in one, two or three weeks after breaking out of a sound base, and the market is in a healthy uptrend. Try to hold it for at least eight weeks to see if it can be held for a bigger long-term gain. Stocks that get off to a fast start often yield the biggest profits.
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"Those could be your big leaders and should be held for a potentially greater profit," O'Neil wrote in "How to Make Money in Stocks."
Here are more reasons to take many gains on the way up:
One, all of your stocks aren't going to be huge winners. Many, probably most, of the stocks you buy in a bull market are going to be profitable, but won't become among the best winners of the decade.
Two, you will have inevitable losses along the way, which should be cut at no more than 8%. So you can lose twice and win once and still be ahead.
Three, taking a profit feels good. It boosts confidence when you move some cash to the realized capital gains column in your brokerage account.
Four, money committed to a stock going through a monthslong correction is dead money. That cash could be applied to another stock that's rising and even stronger than the one you just sold.
Five, you can always buy a stock back if it presents another valid buy point.
In 2013, Las Vegas Sands (LVS) broke out of a cup-with-handle base with a 58.21 buy point during the week ended Sept. 16. Over seven weeks, it gained 26%, a good time to take profits (1).
It paused to build a six-week flat base with a 73.59 proper buy point (2). Sands broke out again in the week ended Dec. 6, 2013, but the gain was limited to 12%. Then Sands pulled back and surrendered all of those gains.
The Third Was Not A Charm
A third breakout from a faulty base failed almost instantly. Notice on the chart how the cup was V-shaped. Also, the base was five weeks long, below the minimum requirement of six weeks for a cup without handle.
By September 2014, Sands retreated all the way back to its early breakout price of 58.21. The casino resort operator continued to fall sharply in 2015 as China's government began to clamp down on big spending in Macau, the only place in the country where gambling is legalized. By January 2016, shares in Las Vegas Sands dropped to a low of 34.55, down more than 60% from the 88.28 peak in March 2014.
Peaking Before Fundamentals Slow Down
The problems with the third base and the sharp decline foreshadowed a slowdown in Las Vegas Sands' fundamentals. Earnings per share showed excellent growth, starting with a 48% jump in the second quarter of 2013 and followed with increases of 78%, 33%, 37% and 31% in the next four quarters through the second quarter of 2014. Revenue also grew at a hot rate over the same period.
But in the second quarter of 2014, a 12% top-line increase showed a marked slowdown from gains of 26%, 32%, 19% and 21%.
When a company has logged four quarters or more in a row of fantastic profit and revenue gains, you can expect a material slowdown to occur. Indeed, Sands saw revenue dip 1% to $3.53 billion in the third quarter of 2014. Earnings rose only 2% to 84 cents a share after catapulting 78% higher in the year-ago quarter.
A version of this column originally ran in the July 1, 2015, edition of IBD. Please follow Chung on Twitter at both @SaitoChung and @IBD_DChung for more on growth stocks, chart analysis, sell rules and financial markets.
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As an enthusiast and expert in stock market investing, I bring a wealth of knowledge and experience to guide investors in making informed decisions. My understanding is deeply rooted in both historical context and contemporary market dynamics. Let's delve into the concepts discussed in the article about when to sell stocks:
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Cutting Losses and Managing Risk: The article emphasizes the importance of limiting downside risk in every trade. It suggests cutting losses in each investment at 7% to 8% or less. This risk management strategy is crucial to ensure that losses are controlled, allowing investors to preserve their capital for future opportunities.
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Taking Profits at 20-25% Gain: The golden rule mentioned in the article is to take most of your profits when a stock has reached a 20% to 25% gain after breaking out. This strategy is attributed to William O'Neil, the founder of Investor's Business Daily (IBD), who observed that many stocks tended to correct sharply after reaching this level of gain. This approach aims to secure gains and prevent potential downturns.
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Selling Strategies Based on Market Conditions: The article advises adjusting selling strategies based on market conditions. In choppy markets where decent gains are challenging, exiting the entire position may be considered. However, in favorable market conditions with a stock still in its early stages of a run, selling a portion of the position (e.g., a third or half) is recommended to lock in gains while monitoring the stock's behavior for further decisions.
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Exception to the Rule: An exception to the 20-25% profit-taking rule is mentioned. If a stock experiences a rapid 20% or more gain in one to three weeks after breaking out of a sound base and the market is in a healthy uptrend, the article suggests holding the stock for at least eight weeks to explore the potential for a larger long-term gain.
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Reasons for Taking Profits: The article provides several reasons for taking profits, including the recognition that not all stocks will be huge winners, the inevitability of losses, the psychological boost from realizing gains, the opportunity cost of holding onto a stock going through a lengthy correction, and the flexibility to buy back a stock at another valid buy point.
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Case Study - Las Vegas Sands (LVS): The article concludes with a case study involving Las Vegas Sands (LVS), illustrating the importance of following selling rules. It highlights the significance of recognizing chart patterns, such as cup-with-handle bases, and how fundamental factors, like a slowdown in earnings and revenue growth, can signal potential issues for a stock.
In summary, the article provides a comprehensive guide on when to sell stocks, incorporating risk management, profit-taking rules, market conditions, and real-world examples to help investors navigate the complexities of the stock market.
